-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NU2F7y6lzppgSz/O0IlzeTTVXv6Vmefadicqd9LC1vJ1pgfZVABm5lNBYyVWC/yP /LG7MrXBMfklPfPIaTMGdw== 0000897101-97-000300.txt : 19970324 0000897101-97-000300.hdr.sgml : 19970324 ACCESSION NUMBER: 0000897101-97-000300 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970321 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNS INC /DE/ CENTRAL INDEX KEY: 0000814258 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 411580270 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16612 FILM NUMBER: 97560518 BUSINESS ADDRESS: STREET 1: PO BOX 39802 CITY: MINNEAPOLIS STATE: MN ZIP: 55439 BUSINESS PHONE: 6128206696 MAIL ADDRESS: STREET 2: PO BOX 39802 CITY: MINNEAPOLIS STATE: MN ZIP: 55439 10-K 1 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 [NO FEE REQUIRED] For the fiscal year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the Transition period from _________ to __________ COMMISSION FILE NUMBER: 0-16612 CNS, INC. (Exact name of registrant as specified in its charter) DELAWARE 41-1580270 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) P.O. BOX 39802 MINNEAPOLIS, MN 55439 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (612) 820-6696 Securities registered pursuant to section 12(b) of the act: none Securities registered pursuant to section 12(g) of the act: Title of each class Common stock, par value of $.01 per share 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, 1997, assuming as market value the price of $12.375 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 $212,554,819. As of March 3, 1997, the Company had outstanding 19,256,243 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, 1996 and (ii) Proxy Statement for its Annual Meeting of Stockholders to be held in April 1997, a definitive copy of which will be filed with the Commission within 120 days of December 31, 1996, are incorporated by reference into Parts II and III of this Form 10-K.
TABLE OF CONTENTS Page PART I ---- Item 1. Business................................................................... 3 Item 2. Properties................................................................. 14 Item 3. Legal Proceedings.......................................................... 14 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 and Results of Operations............................................... 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..................................................... 17 SIGNATURES ........................................................................... 18
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 the following factors: (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(R) nasal strip technology, and the Company has been sued for patent infringement (see Item 3, Legal Proceedings); (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, included in its Registration Statement on Form S-3 (File No. 333-01589) filed with the Securities and Exchange Commission. PART I ITEM 1. BUSINESS GENERAL CNS, Inc. (the "Company") designs, manufactures and markets consumer products, including the Breathe Right nasal strip which 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 also has entered into several agreements to market or license certain new medical consumer products that are in various stages of marketing, evaluation and testing. 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 has received 510(k) clearances from the FDA to market the Breathe Right nasal strip for improvement of nasal breathing (October 1993), reduction or elimination of snoring (November 1995), temporary relief of nasal congestion (February 1996) and temporary relief of breathing difficulties due to deviated nasal septum (May 1996). 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 over-the-counter ("OTC") market in quantities of 10 or 30 strips per box and for sporting goods retailers in quantities of eight 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, $11.99 for a box of 30 and $4.99 for an eight count sports pack. MARKETS The Breathe Right nasal strip is sold in the consumer OTC market, the professional medical market and the athletic market. Because a substantial number of people may be included in more than one market, the number of potential customers for the Breathe Right nasal strip does not equal the aggregate population of these markets. CONSUMER OTC MARKET. Air impedence 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. SNORING. Market research commissioned by the Company indicates that, in the U.S., approximately 78% of all households have at least one snorer, approximately 37 million people snore regularly (every night) and 50 million people snore occasionally. In a clinical study conducted at the Sleep Disorders Center in Cincinnati, Ohio, Breathe Right nasal strips were effective in reducing snoring loudness or eliminating snoring in 75% of the participants in the study. Additional clinical studies show that Breathe Right nasal strips may improve the quality of sleep. The Company believes that the Breathe Right nasal strip is the only non-prescription product in wide retail distribution that the FDA has cleared to market for the reduction or elimination of snoring. NASAL CONGESTION/OBSTRUCTION. The Company believes the Breathe Right nasal strip can in many cases benefit those people who suffer from nasal congestion, stuffy nose and nasal obstruction resulting from the following conditions: (i) the common cold; (ii) allergies and sinus disease -- approximately 35 million people in the U.S.; and (iii) deviated nasal septum and other nasal structural deficiencies -- approximately 12 million people in the U.S. Clinical studies at the Oklahoma Allergy Clinic in Oklahoma City, Oklahoma and at Park Nicollet Clinic in Minneapolis, Minnesota have shown that the product relieves some of the symptoms associated with nasal congestion caused by allergies, and a clinical study at Mount Sinai Hospital, Toronto, Ontario has shown that the product relieves some of the symptoms of nasal obstruction due to septal deviation. For nasal congestion applications, the Company believes that the Breathe Right nasal strip is often used as either an alternative or adjunct to decongestant drugs (including nasal sprays and oral decongestants). PROFESSIONAL MEDICAL MARKET. In October 1996, the Company entered into a Distributorship Agreement with Healthdyne Technologies, Inc. ("Healthdyne") pursuant to which Healthdyne will market the Breathe Right nasal strip to the professional medical market. The Company believes that patients receiving various treatments for sleep apnea and chronic lung disease may become regular users of the product if it is recommended to them by their physicians. The Company believes that there are over one million sleep apnea and chronic lung disease patients receiving treatments and an additional 15 million chronic lung disease sufferers that may benefit from use of the Breathe Right nasal strip. The Company also believes that awareness of the product by physicians will increase their recommendations of the product for other applications. 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. Clinical studies are being conducted to establish the benefit of use during athletic activity. 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. BUSINESS STRATEGY The Company's strategy for increasing sales of its Breathe Right nasal strip and expanding its product line consists of: INCREASING NEW CONSUMER PRODUCT TRIAL. The Company uses a combination of advertising, promotions and celebrity endorsements to increase consumer awareness of the Breathe Right nasal strip and its benefits and to encourage initial consumer trial of the product. The Company's advertising campaign utilizes widely distributed magazines, nationally syndicated radio programs and network and cable television to try to establish the Breathe Right nasal strip as a leading OTC branded product for the relief of snoring and nasal congestion. A research study commissioned by the Company indicates that, of the persons surveyed in January 1996 and January 1997, total consumer awareness of an unidentified device used over the nose to improve nasal breathing and reduce snoring increased from 53% to 74% and household trial of the Breathe Right nasal strip increased from 5% to 9%. INCREASING REPEAT USAGE. According to research data collected by an independent, nationally recognized consumer market research firm, approximately 32% in the U.S. of those who have purchased Breathe Right nasal strips have purchased additional product. To encourage repeat usage, in 1995 the Company introduced a 30 count box, which carries a suggested retail price 20% less per strip than the 10 count box. Although the 30 count box is in fewer stores than the 10 count box, the 30 count box accounted for approximately 48% of the Company's domestic sales in 1996. The Company intends to try to increase the retail distribution of the 30 count box. EXPANDING PRESENCE IN INTERNATIONAL MARKETS. In August 1995, the Company signed an exclusive international distribution agreement with 3M to market the Breathe Right nasal strip outside the U.S. and Canada. 3M introduced the product in over 30 countries in 1996 and expects the product to be available at retail in additional international markets by the end of 1997. EXPANDING PRESENCE IN THE PROFESSIONAL MEDICAL MARKET. In October 1996, the Company entered into a Distributorship Agreement with Healthdyne pursuant to which Healthdyne will market the Breathe Right nasal strip to the professional medical market. The Company seeks to increase its presence in the professional medical market, which includes patients receiving various treatments for sleep apnea and chronic lung disease. The Company believes that educating the professional medical market will lead to both recommendations for use of the product in that market and for other applications, such as for snoring and nasal congestion. MARKETING NEW PRODUCTS THAT LEVERAGE DISTRIBUTION CHANNELS. The Company has established a strong brand identity for the Breathe Right name and strong distribution channels. The Company plans to leverage its marketing and distribution strengths by acquiring or licensing the rights to those products that it believes have merit and attempt to bring them to market. In 1996, the Company began marketing the TheraPatch(TM), which is an external analgesic manufactured by LecTec Corporation. There can be no assurance that the Company will ever market any of the Company's other new products. MARKETING STRATEGY The Company began broad consumer marketing of the Breathe Right nasal strip in September 1994. According to data collected by Information Resources, Inc. ("IRI"), the Breathe Right nasal strip became a leading sales volume producer during 1995 in the cough, cold and allergy section of drug, grocery and mass merchant stores nationwide. In September 1995, the Company received two REX (retail excellence) awards from Drug Stores News magazine. The first award named the Breathe Right nasal strip as the best new product in the cough, cold and allergy section in U.S. drug stores. The second award named the product the "market maker of the year," the single most important product which disproportionately increased traffic and profits in U.S. drug stores. The Company's marketing efforts are primarily directed to the OTC market. The Company's advertising focuses on the snoring and nasal congestion applications for the product. 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). The Company has developed a joint promotion with Johnson & Johnson for April 1997 in which samples of Tylenol PM will be included in Breathe Right nasal strip packages and samples of Breathe Right nasal strips will be included in Tylenol PM packages. 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 an OTC product, sales of the product will depend in part upon the degree to which the consumer is aware of the product and is satisfied with its use, which also influences repeat usage and word of mouth referrals. Research data collected by a nationally recognized consumer market research firm indicates that approximately 32% of those in the U.S. who have purchased Breathe Right nasal strips have purchased additional product. The Company has conducted periodic consumer awareness surveys in which 1,000 consumers over the age of 18 were surveyed by telephone. The table set forth below shows the percent of the respondents who had (i) total product awareness, where respondents identified or, if asked, were aware of, a nasal strip as a product designed to help people breathe more easily or provide relief from snoring, (ii) unaided brand name awareness, where the respondents were asked to identify a product worn across the nose to help people breathe and reduce snoring and the respondents identified the Breathe Right brand name, and (iii) purchased product, those who have purchased Breathe Right nasal strips.
Mar. Sept. Jan. April July Oct. Jan. 1995 1995 1996 1996 1996 1996 1997 ---- ---- ---- ---- ---- ---- ---- Total Product Awareness................. 32% 41% 53% 74% 72% 70% 74% Unaided Brand Name Awareness............ 2% 3% 7% 12% 12% 12% 14% Purchased Product....................... 1% 2% 5% 8% 8% 8% 9%
DOMESTIC DISTRIBUTION OTC MARKET. The Breathe Right nasal strip is sold as an OTC 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 OTC customers for the Breathe Right nasal strip include national chains of drug stores, grocery stores and mass merchants such as Walgreens, RiteAid, REVCO, Kroger, Safeway, Wal-Mart and Kmart and warehouse clubs such as Sam's Club, as well as regional and independent stores in the same store categories. In 1996, one retailer accounted for approximately 14% of Breathe Right nasal strip sales. Although this retailer accounted for less than 4% of the retail stores that carried the product, the loss of this customer or any other large retailer would require the Company to replace the lost sales through other retail outlets and could temporarily disrupt distribution of the Breathe Right nasal strip. PROFESSIONAL MEDICAL MARKET. The Company believes that establishing a strong presence in the professional medical market will not only increase sales to this market, but will also result in physicians recommending the product for other applications. The Company has entered into an agreement with Healthdyne, a national manufacturer and distributor of pulmonary products, pursuant to which Healthdyne will distribute the product to hospitals, clinics and other providers of in-home medical equipment and health care services. ATHLETIC MARKET. Largely as a result of the exposure that the Breathe Right nasal strips received when NFL football players began wearing them, many sporting goods retailers expressed an interest in carrying the product. A special package has been developed for this market. The Breathe Right nasal strips sports package is distributed to mass merchant sports departments and sporting goods stores. In addition, many drug stores carry the sports package in their sports medicine section. INTERNATIONAL DISTRIBUTION The Company executed an international distributor agreement with 3M in August 1995 pursuant to which 3M has the exclusive right to distribute the Breathe Right nasal strip outside of the U.S. and Canada. 3M has operations in over 60 foreign countries. The product is marketed internationally under the co-brand of "3M Breathe Right nasal strips" in order to benefit from both 3M's brand name and the publicity that the Breathe Right brand name has received. Under the terms of the agreement, 3M buys product from the Company either in finished form in 3M boxes or in bulk quantities to be packaged by 3M's international subsidiaries. All sales to 3M are denominated in U.S. dollars. 3M is responsible for obtaining all necessary regulatory approvals outside of the U.S. and for all marketing and selling expenses. The agreement contains certain minimum performance objectives and breakup provisions. The product was on retail shelves in over 30 countries by the end of 1996. In 1995, the Company arranged with LOCIN Industries, a Canadian dental floss company, to establish distribution in the Canadian market. LOCIN distributes the product to drug stores in Canada. During 1996, LOCIN purchased product in bulk and packaged it at its facility and assumed responsibility for cooperative advertising programs. THERAPATCH(TM) EXTERNAL ANALGESIC PATCH The Company began national distribution of the TheraPatch at the end of 1996. The Company has the right to market the TheraPatch pursuant to a Marketing and Distribution Agreement with Natus Corporation and LecTec Corporation, the manufacturers of the TheraPatch. The TheraPatch is a 2" by 3" external analgesic patch designed for temporary relief of pain from arthritis, simple backaches and muscular aches and strains. The patch is coated with a proprietary hydrogel formulation which, when placed on the skin, creates a cutaneous sensation that interferes with the sensation of pain. The Company believes that the TheraPatch design allows it to provide longer lasting relief (four to six hours) than similar patches or external analgesic creams (60 to 90 minutes) currently on the market. The Company, however, will not be able to make any claims as to duration without FDA approval. The FDA has issued a deferment letter to the product's manufacturer which allows the product to be marketed and defers the product's regulatory status until the FDA publishes a Final Monograph on External Analgesics. After the Final Monograph is published, if the product does not comply with the FDA's requirements listed in the Final Monograph, the product's manufacturer will have one year to bring it into compliance. POTENTIAL LINE EXTENSIONS AND NEW PRODUCTS BREATHE RIGHT NASAL STRIP ENHANCEMENTS AND LINE EXTENSIONS. The Company is currently evaluating a number of enhancements to the existing Breathe Right nasal strip product line. These enhancements include a modification that would increase the dilating force of the strip without diminishing the strip's ability to stay in place, an enhancement that would reduce the potential for irritation over the top of the nose and production of nasal strips that are different in appearance from the current product. NEW PRODUCTS. As a result of the Company's established distribution channels and highly visible success with the Breathe Right nasal strip, the Company has frequently been 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 plans to incur costs of approximately $1.0 million relating to evaluation and test marketing of these products in 1997. 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. The Company has an exclusive, worldwide license agreement covering the Pollen-Guard(TM) Gel, which is an ionized gel product that is applied around the nostrils, dries clear, colorless and odorless and creates a local electrostatic field. The Company believes that this product reduces the inhalation of airborne contaminants such as pollen, mold spores and dust, which will thereby reduce allergic symptoms. The Company plans to perform clinical tests on two products that utilize a chemical compound that is used as a common food additive. The Company believes that the compound, when inhaled, may be effective as an adjunct to assist in stopping smoking or as a smoking substitute product, and may also be useful in suppressing appetite, resulting in weight loss, but the Company has not completed any clinical studies on these products to date. The Company is also testing a laryngoscope dental warning system. A laryngoscope is a medical device used in the process of intubation, which involves insertion of a breathing tube into a patient's trachea by passing it through the mouth and throat. During the process of intubation, the laryngoscope's blade has a tendency to be pressed against the patient's top teeth, at times causing damage to those teeth or to adjacent bridge work. The laryngoscope dental warning system uses a disposable warning circuit embedded into a thin plastic strip placed on the bottom of the laryngoscope's blade to warn the user when the blade makes contact with the teeth, allowing the physician to avoid damaging the patient's teeth. 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 insure that they meet quality requirements. The Company inspects its converters on a regular basis and is not aware of any material violation of FDA Good Manufacturing Practice Standards. The Company works closely with its material vendors and converters to reduce scrap and waste, improve efficiency, and improve yields to reduce the manufacturing costs of the product. To ensure consistent quality and favorable pricing, the Company has entered into a multi-year material supply agreement with 3M for the major components of the Breathe Right nasal strip. Although similar materials are currently available from other suppliers, the Company believes that 3M's materials are of superior quality. Although the Company believes that this relationship will not be disrupted or terminated, the inability to obtain sufficient quantities of these components or the need to develop alternative sources in a timely and cost effective manner, if and as required in the future, could adversely affect the Company's operations until new sources of these components become available, if at all. In addition, while the Company does not expect 3M to do so, 3M has the right to discontinue its production or sale of these products at any time with 90 days notice to the Company. COMPETITION The Company believes that the market for decongestant products is highly competitive while there is currently little or no competition in the market for products for the reduction or elimination of snoring. In the U.S., the Company's competition in the OTC market for (i) decongestant products and other cold, allergy and sinus relief products consist primarily of pharmaceutical products and (ii) snoring remedies consist primarily of internal nasal dilators. The Company believes that the patents on the Breather Right nasal strip will limit the ability of others to introduce competitive external nasal dilator products in the United States. However, external nasal dilator products compete in the OTC markets for 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 classes that determine the degree of regulatory control to which the manufacturer of the device is subject. In general, Class I devices involve compliance with labeling and record keeping requirements and are subject to other general controls. Class II devices are subject to performance standards in addition to general controls. Class III devices are those devices, usually invasive, for which pre-market approval (as distinct from pre-market notification) is required before commercial marketing to assure the products' safety and effectiveness. The Breathe Right nasal strip has not yet been classified. Before a new medical device can be introduced into the market, the manufacturer generally must obtain FDA clearance through either a 510(k) pre-market notification or a pre-market approval application ("PMA"). A 510(k) clearance will be granted if the submitted data establish that the proposed device is "substantially equivalent" to a legally marketed Class I or II medical device, or to a Class III medical device for which the FDA has not called for PMAs. The PMA process can be expensive, uncertain and lengthy, frequently requiring from one to several years from the date the PMA is accepted. In addition to requiring clearance for new products, FDA rules may require a filing and waiting period prior to marketing modifications of existing products. The Company has received 510(k) approvals to market the Breathe Right nasal strip as a device that can (i) reduce or eliminate snoring, (ii) temporarily relieve the symptoms of nasal congestion and stuffy nose, (iii) improve nasal breathing by reducing nasal airflow resistance and (iv) temporarily relieve breathing difficulties due to deviated nasal septum. In addition to the Company's medical device products, the Company has entered into an agreement to manufacture and market a smoking substitute and appetite suppressant product that the FDA may classify as a "New Drug." The FDA must approve safety and effectiveness for each labeled use before a New Drug can be sold. As part of the requirements for obtaining approval of a New Drug, the Company will be required to conduct extensive preclinical studies to determine the safety and efficacy of the drug. Upon completion of these studies, the Company will submit an Investigational New Drug application ("IND") to the FDA, which permits the Company to begin clinical trials. These clinical trials of the products must be conducted and the results submitted to the FDA as part of a New Drug Application ("NDA"). The FDA must approve the NDA before pharmaceutical products may be sold in the U.S. The grant of regulatory approvals often takes a number of years and may involve the expenditure of substantial resources. There is no assurance that NDAs will be approved for the Company's products if any are required. Even after initial FDA approval has been granted, further studies may be conducted to provide additional data on safety or efficacy or to obtain approval for marketing the drug as a treatment for disease indications in addition to those originally approved. In addition, the FDA can revoke its approval even after it has initially been given. Sales of the Company's products outside the U.S. are subject to regulatory requirements governing human clinical trials and marketing approval for drugs, and such requirements vary widely from country to country. Under its agreement with the Company, 3M is responsible for obtaining all necessary regulatory approvals outside the U.S. The Company believes it has provided 3M with the necessary documentation to enable 3M to obtain the "CE" mark, an international symbol of quality and compliance with applicable European medical device directives, and 3M is affixing the CE mark on the Company's products in Europe. No assurance can be given that the FDA or state or foreign regulatory agencies will give on a timely basis, if at all, the requisite approvals or clearances for additional applications for the Breathe Right nasal strip or for any of the Company's products which are under development. Moreover, after clearance is given, the Company is required to advise the FDA and these other regulatory agencies of modifications to its products. These agencies have the power to withdraw the clearance or require the Company to change the device or its manufacturing process or labeling, to supply additional proof of its safety and effectiveness or to recall, repair, replace or refund the cost of the medical device if it is shown to be hazardous or defective. The process of obtaining clearance to market products is costly and time-consuming and can delay the marketing and sale of the Company's products. Furthermore, federal, state and foreign regulations regarding the manufacture and sale of medical devices are subject to future change. The Company cannot predict what impact, if any, such changes might have on its business. The Company is also subject to substantial federal, state and local regulation regarding occupational health and safety, environmental protection, hazardous substance control and waste management and disposal, among others. PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS The Company entered into a license agreement in 1992 (the "License Agreement") pursuant to which the Company acquired from the licensor (the "Licensor") the exclusive rights to manufacture and sell the Breathe Right nasal strip. Pursuant to the License Agreement, the Company has the exclusive right to manufacture, sell and otherwise practice any invention, including the Breathe Right nasal strip, claimed in the Licensor's patent applications related thereto and all patents issued in any country which correspond to those applications. The Company must pay royalties to the Licensor based on sales of the Breathe Right nasal strip including certain minimum royalty amounts to maintain its exclusivity. The Company is also responsible for all costs and expenses incurred in obtaining and maintaining patents related to the Breathe Right nasal strip. The Licensor has filed patent applications with the U.S. Patent and Trademark Office seeking patent protection for different aspects of the Breathe Right nasal strip technology. Four of these patent applications have issued as patents, including one with claims that cover the single-body construction of the Breathe Right nasal strip. The Licensor has received notice of allowance in two additional patent applications and one application remains pending. The Licensor has also obtained patent protection on the Breathe Right nasal strip in two foreign countries and has applications pending which seek patent protection in 39 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. The Company has sued two companies for patent infringement in the United States. The Company settled with one company based on its representation that it had not made, used, sold or offered for sale nasal dilators after the issuance of the patents, as described in Item 3, Legal Proceedings. The second company agreed to discontinue making, using, selling or offering for sale external nasal dilator strips. The Company has also initiated suits against two companies for patent infringement in Australia. One has settled and agreed to cease infringing activity and the other company is in administration proceedings. The Company believes its trademarks are important as protection for the Company's names and advertising. The Company has successfully opposed two competitors, and has initiated opposition proceedings against three additional competitors, in the U.S. Patent and Trademark Office for attempting to register trademarks that are substantially similar to "Breathe Right," and has a trademark infringement suit pending against one competitor. There can be no assurance that the Company's technology will not be challenged on the grounds that the Company's products infringe on patents, copyrights or other proprietary information owned or claimed by others or that others will not successfully utilize part or all of the Company's technology without compensation to the Company. The Company will attempt to protect its technologies and proprietary information as trade secrets. EMPLOYEES At March 3, 1997, the Company had 40 full-time and two part-time employees, of whom 15 were engaged in operations, 15 in general administration, 10 in marketing and sales and two in new products and product development. There are no unions representing Company employees. Relations with its employees are believed to be good and there are no pending or threatened labor employment disputes or work interruptions. EXECUTIVE OFFICERS OF THE COMPANY The following table sets forth the names and ages of the Company's Executive Officers together with all positions and offices held with the Company by such Executive Officers. Officers are appointed to serve until the meeting of the Board of Directors following the next Annual Meeting of Shareholders and until their successors have been elected and have qualified.
Name and Age Office ------------ ------ Daniel E. Cohen, M.D. (44) Chairman of the Board, Chief Executive Officer, Treasurer and Director Richard E. Jahnke (48) President, Chief Operating Officer and Director M. W. Anderson, Ph.D. (46) Vice President of Clinical and Regulatory Affairs David J. Byrd (43) Vice President of Finance and Chief Financial Officer William Doubek (41) Vice President of Operations Rihab FitzGerald (45) Vice President of Consumer Sales Kirk P. Hodgdon (37) Vice President of Consumer Marketing Gerhard Tschautscher (40) Vice President of International and Professional Medical Marketing
DANIEL E. COHEN, M.D. has served as the Company's Chairman of the Board since 1993, its Chief Executive Officer since 1989 and a director and the Treasurer since 1982. Dr. Cohen was a founder of the Company and is a board-certified neurologist. RICHARD E. JAHNKE has served as the Company's President and Chief Operating Officer and as a director since 1993. From 1991 to 1993, he was Executive Vice President and Chief Operating Officer of Lemna Corporation, which manufactures and sells waste water treatment systems. From 1986 to 1991, Mr. Jahnke was general manager of the government operations division of ADC Telecommunications, an electronic communications systems manufacturer. From 1982 to 1986, he was Director of Marketing and Business and Technical Development at BMC Industries, Inc. From 1972 to 1982, he held various positions of increasing responsibility in engineering, sales and marketing management at 3M Company. He is also a director of Rehabilicore Inc., a manufacturer of medical devices. M. W. ANDERSON, PH.D. has served as the Company's Vice President of Clinical and Regulatory Affairs and Vice President of Research and Development since 1990. He has served in various capacities since joining the Company in 1984, including Director of Applications Research and Director of Research and Development. Prior to joining the Company in 1984, Dr. Anderson was an Assistant Professor at the University of Minnesota's College of Pharmacy. DAVID J. BYRD has served as the Company's Vice President of Finance and Chief Financial Officer since February 1996. Prior to joining the Company, Mr. Byrd was Chief Financial Officer and Treasurer of Medisys, Inc., a health care services company, since 1991. From 1975 to 1991, Mr. Byrd was employed by Coopers & Lybrand, where he was a partner from 1986 to 1991. Mr. Byrd is a certified public accountant. WILLIAM DOUBEK has served as the Company's Vice President of Operations since 1990, Director of Operations from 1986 to 1990 and was the Company's Senior Engineer from 1982 to 1986. Prior to joining the Company in 1982, Mr. Doubek served as Senior Project Engineer at Medtronic, Inc., a manufacturer of medical devices, Senior Engineer at Micro Control Company, a manufacturer of computer testing equipment, and Electrical Engineer at Palico Instrument Company, a manufacturer of computer testing equipment. RIHAB FITZGERALD has served as the Company's Vice President of Consumer Sales since August 1993, Vice President of Sales and Marketing from 1990 to August 1993 and Director of Marketing from 1985 to 1990. Prior to joining the Company in 1984, Ms. Fitzgerald was employed in sales and marketing with Nicolet Instrument Corporation, a medical devices manufacturer. KIRK P. HODGDON has been the Company's Vice President of Marketing since February 1994. Prior to joining the Company, Mr. Hodgdon served as: Vice President-Management Supervisor at Gage Marketing Communications, a marketing services company, from 1993 to February 1994; Vice President - Account Supervisor at U.S. Communications, a marketing agency, from 1989 to 1993; and Marketing Manager at Land O'Lakes, Inc., a consumer foods cooperative, from 1988 to 1989. GERHARD TSCHAUTSCHER has served as the Company's Vice President of International and Professional Medical Marketing since January 1994 and as a Company Product Director and as the International Sales Marketing and Sales Director between 1988 and December 1993. ITEM 2. PROPERTIES The Company leases approximately 80,000 square feet of office, manufacturing and warehouse space in Bloomington, Minnesota. The lease expires in December 2000. ITEM 3. LEGAL PROCEEDINGS Except as otherwise disclosed in this Form 10-K, no material legal proceedings are pending or known to be contemplated to which the Company is a party or to which any of its property is subject, and the Company knows of no material legal proceedings pending or threatened, or judgments against any director or officer of the Company in his or her capacity as such. In January 1997, the Company was sued for patent infringement in California District Court 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, interests, 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. The Company has also filed a claim against Acutek for false advertising and related offenses by Acutek related to claims Acutek has made about its products and patent rights. Earlier, the Company sued Acutek and Mabco, Inc., a related corporation, for patent infringement. Upon the Company receiving representations that those companies had not made, used, or sold products infringing the patents that protect the Company's Breathe Right device, the suit was settled. The Company will defend the current suit brought against it by Acutek and pursue its counterclaims vigorously. The Company believes that it does not infringe any valid patent claims. In October 1995, an individual commenced a lawsuit against the Company in U.S. District Court for the Northern District of Ohio claiming that the Breathe Right nasal strip infringes the plaintiff's patents relating to a facial cleanser. In May 1996, the suit was dismissed by the District Court and in June 1996 the plaintiff filed an appeal to the United States Court of Appeals for the Sixth Circuit. The appeal was transferred to court of appeals for the Federal Circuit, where it is currently pending. The plaintiff is seeking an undefined amount of monetary damages from the Company and an order enjoining the Company from infringing on his patents. The plaintiff claims his patent covers a facial cleanser for a person's nose. The Company believes that the suit is completely without merit and is vigorously defending itself based upon what it considers meritorious defenses and which were recognized as such by the District Court. 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 19 of the 1996 Annual Report to Shareholders (the "1996 Annual Report"). On March 3, 1997, the last sale price of the Common Stock as reported on the Nasdaq National Market was $12.375. As of March 3, 1997, there were approximately 1,000 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 1996 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 11 of the Company's 1996 Annual Report and is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Balance Sheets of the Company as of December 31, 1995 and 1996, and the related Statements of Operations, Stockholders' Equity and Cash Flows for each of the years in the three-year period ended December 31, 1996, the Notes to the Financial Statements and the Report of KPMG Peat Marwick LLP, independent auditors, is contained in the Company's 1996 Annual Report on pages 12 through 19 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 in April 1997 (the "1997 Proxy Statement"), a definitive copy of which will be filed with the Commission within 120 days of the close of the past fiscal year, and is incorporated herein by reference. Information concerning executive officers is set forth in the Section entitled "Executive Officers of the Company" in Part I of this Form 10-K pursuant to Instruction 3 to paragraph (b) of Item 401 of Regulation S-K. ITEM 11. EXECUTIVE COMPENSATION Information required under this item is contained in the section entitled "Executive Compensation" in the 1997 Proxy Statement and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required under this item is contained in the section entitled "Security Ownership of Principal Shareholders and Management" in the Company's 1997 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, 1996. 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 14, 1997 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 14, 1997 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 - ----------------------------------------- Daniel E. Cohen, M.D. Chairman of the Board and Chief Executive Officer, Treasurer and Director (Principal Executive Officer) /s/ Richard E. Jahnke - ----------------------------------------- Richard E. Jahnke Director, President and Chief Operating Officer /s/ David J. Byrd - ----------------------------------------- David J. Byrd Vice President of Finance and Chief Financial Officer (Principal Financial and Accounting Officer) /s/ Patrick Delaney - ----------------------------------------- Patrick Delaney Director /s/ R. Hunt Greene - ----------------------------------------- R. Hunt Greene Director /s/ Andrew J. Greenshields - ----------------------------------------- Andrew J. Greenshields Director /s/ Richard W. Perkins - ----------------------------------------- Richard W. Perkins Director CNS, INC. 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"). 3.1.1 Certificate of Retirement for the Preferred Stock of the Company which was redeemed and converted to Common Stock on April 16, 1992 (incorporated by reference to Exhibit 3.1.1 to the Company's Registration Statement on Form S-2 filed with the Commission on March 2, 1994 (the "1994 Form S-2")). 3.1.2 Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock (incorporated by reference to Exhibit 1 to the Company's Form 8-A dated July 21, 1995). 3.2 Company's Amended By-Laws (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (the "1991 Form 10-K")). 10.1 CNS, Inc. 1987 Employee Incentive Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-18, Commission File No. 33-14052C). 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 Employment Agreement dated February 22, 1988 between the Company and William Doubek (incorporated by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-2, Commission File No. 33-46120 (the "1992 Form S-2")). 10.5 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). 10.6 CNS, Inc. 1994 Stock Plan (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.7 Distribution Agreement dated August 2, 1995 between the Company and Minnesota Mining and Manufacturing Company (incorporated by reference to Exhibit 10.11 to the 1995 Form 10-K). 10.8 Supply Agreement dated May 17, 1995 between the Company and Minnesota Mining and Manufacturing Company (incorporated by reference to Exhibit 10.12 to the 1995 Form 10-K). 10.9 Asset Purchase Agreement dated May 8, 1995 between the Company and Aequitron Medical, Inc. (incorporated by reference to Exhibit 10.4 to the March 31, 1995 Form 10-Q). 10.10 Non-Exclusive Distributorship Agreement dated May 8, 1995 between the Company and Aequitron Medical, Inc. (incorporated by reference to Exhibit 10.5 to the March 31, 1995 Form 10-Q). 10.11 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). 10.12 License Agreement dated February 26, 1996 between the Company and Scott Dahlbeck, M.D. (incorporated by reference to Exhibit 10.16 to the 1995 Form 10-K). 10.13 Option Agreement dated October 5, 1995 between the Company and TruTek Corp. (incorporated by reference to Exhibit 10.17 to the 1995 Form 10-K). 10.14 Marketing and Distribution Agreement dated as of January 11, 1996 between the Company, Natus Corporation and LecTec Corporation (incorporated by reference to Exhibit 10.18 to the 1995 Form 10-K). 10.15 Employment Agreement between the Company and Dr. Daniel E. Cohen dated April 15, 1996. 10.16 Employment Agreement dated April 15, 1996 between the Company and Richard E. Jahnke. 10.17 Employment Agreement dated April 15, 1996 between the Company and Kirk Hodgdon. 10.18 Employment Agreement dated April 15, 1996 between the Company and David J. Byrd. 11.1 Computation of Net Earnings (Loss) Per Share of Common Stock. 13.1 Selected Information from 1996 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. EX-10.15 2 EMPLOYMENT AGREEMENT Exhibit 10.15 EMPLOYMENT AGREEMENT BETWEEN CNS, INC. AND DANIEL E. COHEN THIS AGREEMENT, made and entered into in the City of Bloomington, State of Minnesota, as of the 15th day of April, 1996, by and between CNS, Inc., a corporation duly organized and existing under the laws of the State of Delaware (the "Corporation") and Daniel E. Cohen, M.D. ("Employee"); ARTICLE 1 EMPLOYMENT 1.1 The Corporation hereby employs Employee and Employee agrees to work for Corporation at such duties as are assigned to him from time to time by the directors and officers of the Corporation. ARTICLE 2 TERM 2.1 The term of this Agreement shall be for a period of one (1) year from the date hereof, unless sooner terminated as hereinafter provided. The Agreement shall thereafter continue in effect from year to year unless altered or terminated as hereinafter provided. ARTICLE 3 DUTIES 3.1 Employee agrees, unless otherwise specifically authorized by the Corporation, to devote his full time and effort to his duties for the profit, benefit and advantage of the business of the Corporation. ARTICLE 4 COMPENSATION 4.1 The Corporation agrees to pay Employee a salary of One Hundred Fifty Thousand Dollars ($150,000) per year, payable bi-monthly, as adjusted from time to time by the Corporation's Board of Directors; an automobile expense allowance of $500 per month; and other benefits as adopted from time to time by the Corporation. In addition, Employee may earn cash bonus amounts as established by the Board of Directors from time to time. ARTICLE 5 INSURANCE 5.1 Employee agrees that the Corporation may, from time to time, apply for and take out in its own name and at its own expense, life, health, accident, or other insurance upon Employee that the Corporation may deem necessary or advisable to protect its interests hereunder; and Employee agrees to submit to any medical or other examination necessary for such purposes and to assist and cooperate with the Corporation in preparing such insurance; and Employee agrees that he shall have no right, title, or interest in or to such insurance. ARTICLE 6 NONCOMPETITION 6.1 The Corporation and the Employee acknowledge that: a. The Corporation's business is highly competitive; b. The essence of such business consists of confidential information and trade secrets as described in Article 7, all of which are zealously protected and kept secret by the Corporation; c. In the course of his employment, Employee will acquire the information described in Article 7 and that the Corporation would be adversely affected if such information subsequently, and in the event of the termination of the Employee's employment, is used for the purposes of competing with the Corporation; d. The Corporation markets its products throughout the United States; and e. For these reasons, both the Corporation and the Employee further acknowledge and agree that the restrictions contained herein are reasonable and necessary for the protection of their respective, legitimate interests. 6.2 Employee agrees that from and after the date hereof for the term of employment specified in Article 2 above and two (2) years after termination of his employment with the Corporation, he will not, without the express written permission of the Corporation, directly or indirectly own, manage, operate, control, lend money to, endorse the obligations of, or participate or be connected as an officer, 5% or more stockholder of a publicly-held company, stockholder of a closely-held company, employee, partner, or otherwise, with any enterprise or individual engaged in the business of developing, manufacturing or marketing products that have been, are being or are planned to be developed by the Corporation and will not in any manner, either directly or indirectly, compete with the Corporation in such business. It is understood and acknowledged by both parties that, inasmuch as the Corporation's products are marketed worldwide, this covenant not to compete shall be enforced throughout the United States and in any other country in which the Corporation is doing business as of the date of Employee's termination of employment and in any country for which the Corporation has developed or is in the process of developing a marketing plan for its products, even if such plan is not yet in effect. 6.3 Employee, during the term of his employment by the Corporation, shall at all times keep the Corporation informed of any business activity and outside employment, and shall not engage in any activity or employment which may be in conflict with the Corporation's interests. 6.4 If the Employee should breach any of the provisions of this Article 6, Corporation may enjoin him from continued breach, in addition to pursuing any other available legal and equitable remedies. ARTICLE 7 CONFIDENTIAL INFORMATION AND TRADE SECRETS 7.1 Employee has acquired and will acquire information and knowledge respecting the intimate and confidential affairs of the Corporation including, without limitation, confidential information with respect to the Corporation's products, packages, improvements, designs, practices, sales or distribution methods and other confidential information pertaining to the Corporation's business or financial affairs, which may or may not be patentable, which are developed by the Corporation at considerable time and expense, and which could be unfairly utilized in competition with the Corporation. The term "trade secret" shall be defined as follows: A trade secret may consist of any formula, pattern, device or compilation of information which is used in one's business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it. Accordingly, Employee agrees that he shall not, during the period of his employment hereunder or thereafter, use for his own benefit such confidential information or trade secrets acquired during the term of his employment by the Corporation. Further, during the period of his employment hereunder and thereafter, the Employee shall not, without the written consent of the Board of Directors of the Corporation or a person duly authorized thereby, disclose to any person, other than an employee of the Corporation or a person to whom disclosure is reasonably necessary or appropriate in connection with the performance by the Employee of his duties, any confidential information or trade secrets obtained by him while in the employ of the Corporation. 7.2 Upon termination of employment, Employee agrees to deliver to the Corporation all materials that include confidential information or trade secrets, such as customer lists, product formulations, instruction sheets, drawings, manuals, letters, notes, notebooks, books, reports and copies thereof, and all other materials of a confidential nature which belong to or relate to the business of the Corporation. ARTICLE 8 IMPROVEMENTS AND INVENTIONS 8.1 Employee shall promptly and fully disclose to the Corporation, any and all ideas, improvements, discoveries and inventions, whether or not they are believed to be patentable (all of which are hereinafter referred to as "Inventions"), which Employee conceives or first actually reduces to practice, either solely or jointly with others, during the period of Employee's employment or within two years after termination of employment, and which relate to the business now or hereafter carried on or presently part of the business plan of the Corporation or which results from any work performed by Employee for the Corporation. 8.2 All such Inventions shall be the sole and exclusive property of the Corporation, and during the term of his employment and thereafter, whenever requested to do so by the Corporation, Employee shall execute and assign any and all applications, assignments and other instruments which the Corporation shall deem necessary or convenient in order to apply for and obtain Letters Patent of the United States and/or of any foreign countries for such Inventions and in order to assign and convey to the Corporation or its nominee the sole and exclusive right, title and interest in and to such Inventions, and Employee will render aid and assistance in any interference or litigation pertaining thereto, all expenses reasonably incurred by Employee at the request of the Corporation shall be borne by the Corporation. 8.3 To the extent, if any, that Minnesota law is determined to apply to the enforceability of this Agreement, Minnesota Statute Section 181.78 provides that the Agreement does not apply, and written notification is hereby given to the Employee that this Agreement does not apply, to an Invention for which no equipment, supplies, facility or trade secret information of the Corporation was used and which was developed entirely on the Employee's own time, and (1) which does not relate (a) directly to the business of the Corporation, or (b) to the Corporation's actual or demonstrably anticipated research or development, or (2) which does not result from any work performed by the Employee for the Corporation. ARTICLE 9 JUDICIAL CONSTRUCTION 9.1 The Employee believes and acknowledges that the provisions contained in this Agreement, including the covenants contained in Articles 6, 7 and 8 of this Agreement, are fair and reasonable. Nonetheless, it is agreed that if a court finds any of these provisions to be invalid in whole or in part under the laws of any state, such finding shall not invalidate the covenants, nor the Agreement in its entirety, but rather the covenants shall be construed and/or blue-lined, reformed or rewritten by the court as if the most restrictive covenants permissible under applicable law were contained herein. ARTICLE 10 RIGHT TO INJUNCTIVE RELIEF 10.1 Employee acknowledges that a breach by the Employee of any of the terms of Articles 6, 7, or 8 of this Agreement will render irreparable harm to the Corporation; and that the Corporation shall therefore be entitled to any and all equitable relief, including, but not limited to, injunctive relief, and to any other remedy that may be available under any applicable law or agreement between the parties, and to recover from the Employee all costs of litigation including, but not limited to, attorneys' fees and court costs. ARTICLE 11 TERMINATION 11.1 Either party shall have the right to terminate this Agreement upon ninety (90) days' notice to the other, and the Corporation shall pay Employee until the date of termination, unless the Corporation terminates the Agreement because the Employee has violated either Articles 6, 7 or 8, in which case no additional compensation shall be payable to Employee. Employee acknowledges that any employment and compensation can be terminated with or without cause at any time by the Corporation. ARTICLE 12 CESSATION OF CORPORATE BUSINESS 12.1 This Agreement shall cease and terminate if the Corporation shall discontinue its business, and all rights and liabilities thereunder shall cease, except as provided in Article 13. ARTICLE 13 ASSIGNMENT 13.1 The Corporation shall have the right to assign this contract to its successors or assigns, and all covenants or agreements hereunder shall inure to the benefit of and be enforceable by or against its successors or assigns. 13.2 The terms "successors" and "assigns" shall include any corporation which buys all or substantially all of the Corporation's assets, or a controlling portion of its stock, or with which it merges or consolidates. ARTICLE 14 FAILURE TO DEMAND, PERFORMANCE AND WAIVER 14.1 The Corporation's failure to demand strict performance and compliance with any part of this Agreement during the Employee's employment shall not be deemed to be a waiver of the Corporation's rights under this Agreement or by operation of law. Any waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof. ARTICLE 15 ENTIRE AGREEMENT 15.1 The Corporation and Employee acknowledge that this Agreement contains the full and complete agreement between and among the parties, that there are no oral or implied agreements or other modifications not specifically set forth herein, and that this Agreement supersedes any prior agreements or understandings, if any, between the Corporation and Employee, whether written or oral. The parties further agree that no modifications of this Agreement may be made except by means of a written agreement or memorandum signed by the parties. ARTICLE 16 GOVERNING LAW 16.1 The parties acknowledge that the Corporation's principal place of business is located in the State of Minnesota, that this Agreement has been entered into in the State of Minnesota and that they wish legal certainty and predictability as to the terms of their undertaking. Accordingly, the parties hereby agree that this Agreement shall be construed in accordance with the laws of the State of Minnesota. IN WITNESS WHEREOF, the Corporation has hereunto signed its name and Employee hereunder has signed his name, all as of the day and year first-above written. CNS, INC. By /s/ Richard E. Jahnke ------------------------ Richard E. Jahnke President EMPLOYEE /s/ Daniel E. Cohen ----------------------- Daniel E. Cohen, M.D. EX-10.16 3 EMPLOYMENT AGREEMENT Exhibit 10.16 EMPLOYMENT AGREEMENT BETWEEN CNS, INC. AND RICHARD E. JAHNKE THIS AGREEMENT, made and entered into in the City of Bloomington, State of Minnesota, as of the 15th day of April, 1996, by and between CNS, Inc., a corporation duly organized and existing under the laws of the State of Delaware (the "Corporation") and Richard E. Jahnke ("Employee"); ARTICLE 1 EMPLOYMENT 1.1 The Corporation hereby employs Employee and Employee agrees to work for Corporation at such duties as are assigned to him from time to time by the directors and officers of the Corporation. ARTICLE 2 TERM 2.1 The term of this Agreement shall be for a period of one (1) year from the date hereof, unless sooner terminated as hereinafter provided. The Agreement shall thereafter continue in effect from year to year unless altered or terminated as hereinafter provided. ARTICLE 3 DUTIES 3.1 Employee agrees, unless otherwise specifically authorized by the Corporation, to devote his full time and effort to his duties for the profit, benefit and advantage of the business of the Corporation. ARTICLE 4 COMPENSATION 4.1 The Corporation agrees to pay Employee a salary of One Hundred Fifty Thousand Dollars ($150,000) per year, payable bi-monthly, as adjusted from time to time by the Corporation's Board of Directors; an automobile expense allowance of $500 per month; and other benefits as adopted from time to time by the Corporation. In addition, Employee may earn cash bonus amounts as established by the Corporation's Board of Directors from time to time. ARTICLE 5 INSURANCE 5.1 Employee agrees that the Corporation may, from time to time, apply for and take out in its own name and at its own expense, life, health, accident, or other insurance upon Employee that the Corporation may deem necessary or advisable to protect its interests hereunder; and Employee agrees to submit to any medical or other examination necessary for such purposes and to assist and cooperate with the Corporation in preparing such insurance; and Employee agrees that he shall have no right, title, or interest in or to such insurance. ARTICLE 6 NONCOMPETITION 6.1 The Corporation and the Employee acknowledge that: a. The Corporation's business is highly competitive; b. The essence of such business consists of confidential information and trade secrets as described in Article 7, all of which are zealously protected and kept secret by the Corporation; c. In the course of his employment, Employee will acquire the information described in Article 7 and that the Corporation would be adversely affected if such information subsequently, and in the event of the termination of the Employee's employment, is used for the purposes of competing with the Corporation; d. The Corporation markets its products throughout the United States; and e. For these reasons, both the Corporation and the Employee further acknowledge and agree that the restrictions contained herein are reasonable and necessary for the protection of their respective, legitimate interests. 6.2 Employee agrees that from and after the date hereof for the term of employment specified in Article 2 above and one (1) year after termination of his employment with the Corporation, he will not, without the express written permission of the Corporation, directly or indirectly own, manage, operate, control, lend money to, endorse the obligations of, or participate or be connected as an officer, 5% or more stockholder of a publicly-held company, stockholder of a closely-held company, employee, partner, or otherwise, with any enterprise or individual engaged in the business of developing, manufacturing or marketing products that have been, are being or are planned to be developed by the Corporation and will not in any manner, either directly or indirectly, compete with the Corporation in such business. It is understood and acknowledged by both parties that, inasmuch as the Corporation's products are marketed worldwide, this covenant not to compete shall be enforced throughout the United States and in any other country in which the Corporation is doing business as of the date of Employee's termination of employment and in any country for which the Corporation has developed or is in the process of developing a marketing plan for its products, even if such plan is not yet in effect. 6.3 Employee, during the term of his employment by the Corporation, shall at all times keep the Corporation informed of any business activity and outside employment, and shall not engage in any activity or employment which may be in conflict with the Corporation's interests. 6.4 If the Employee should breach any of the provisions of this Article 6, Corporation may enjoin him from continued breach, in addition to pursuing any other available legal and equitable remedies. ARTICLE 7 CONFIDENTIAL INFORMATION AND TRADE SECRETS 7.1 Employee has acquired and will acquire information and knowledge respecting the intimate and confidential affairs of the Corporation including, without limitation, confidential information with respect to the Corporation's products, packages, improvements, designs, practices, sales or distribution methods and other confidential information pertaining to the Corporation's business or financial affairs, which may or may not be patentable, which are developed by the Corporation at considerable time and expense, and which could be unfairly utilized in competition with the Corporation. The term "trade secret" shall be defined as follows: A trade secret may consist of any formula, pattern, device or compilation of information which is used in one's business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it. Accordingly, Employee agrees that he shall not, during the period of his employment hereunder or thereafter, use for his own benefit such confidential information or trade secrets acquired during the term of his employment by the Corporation. Further, during the period of his employment hereunder and thereafter, the Employee shall not, without the written consent of the Board of Directors of the Corporation or a person duly authorized thereby, disclose to any person, other than an employee of the Corporation or a person to whom disclosure is reasonably necessary or appropriate in connection with the performance by the Employee of his duties, any confidential information or trade secrets obtained by him while in the employ of the Corporation. 7.2 Upon termination of employment, Employee agrees to deliver to the Corporation all materials that include confidential information or trade secrets, such as customer lists, product formulations, instruction sheets, drawings, manuals, letters, notes, notebooks, books, reports and copies thereof, and all other materials of a confidential nature which belong to or relate to the business of the Corporation. ARTICLE 8 IMPROVEMENTS AND INVENTIONS 8.1 Employee shall promptly and fully disclose to the Corporation, any and all ideas, improvements, discoveries and inventions, whether or not they are believed to be patentable (all of which are hereinafter referred to as "Inventions"), which Employee conceives or first actually reduces to practice, either solely or jointly with others, during the period of Employee's employment or within two years after termination of employment, and which relate to the business now or hereafter carried on or presently part of the business plan of the Corporation or which results from any work performed by Employee for the Corporation. 8.2 All such Inventions shall be the sole and exclusive property of the Corporation, and during the term of his employment and thereafter, whenever requested to do so by the Corporation, Employee shall execute and assign any and all applications, assignments and other instruments which the Corporation shall deem necessary or convenient in order to apply for and obtain Letters Patent of the United States and/or of any foreign countries for such Inventions and in order to assign and convey to the Corporation or its nominee the sole and exclusive right, title and interest in and to such Inventions, and Employee will render aid and assistance in any interference or litigation pertaining thereto, all expenses reasonably incurred by Employee at the request of the Corporation shall be borne by the Corporation. 8.3 To the extent, if any, that Minnesota law is determined to apply to the enforceability of this Agreement, Minnesota Statute Section 181.78 provides that the Agreement does not apply, and written notification is hereby given to the Employee that this Agreement does not apply, to an Invention for which no equipment, supplies, facility or trade secret information of the Corporation was used and which was developed entirely on the Employee's own time, and (1) which does not relate (a) directly to the business of the Corporation, or (b) to the Corporation's actual or demonstrably anticipated research or development, or (2) which does not result from any work performed by the Employee for the Corporation. ARTICLE 9 JUDICIAL CONSTRUCTION 9.1 The Employee believes and acknowledges that the provisions contained in this Agreement, including the covenants contained in Articles 6, 7 and 8 of this Agreement, are fair and reasonable. Nonetheless, it is agreed that if a court finds any of these provisions to be invalid in whole or in part under the laws of any state, such finding shall not invalidate the covenants, nor the Agreement in its entirety, but rather the covenants shall be construed and/or blue-lined, reformed or rewritten by the court as if the most restrictive covenants permissible under applicable law were contained herein. ARTICLE 10 RIGHT TO INJUNCTIVE RELIEF 10.1 Employee acknowledges that a breach by the Employee of any of the terms of Articles 6, 7, or 8 of this Agreement will render irreparable harm to the Corporation; and that the Corporation shall therefore be entitled to any and all equitable relief, including, but not limited to, injunctive relief, and to any other remedy that may be available under any applicable law or agreement between the parties, and to recover from the Employee all costs of litigation including, but not limited to, attorneys' fees and court costs. ARTICLE 11 TERMINATION 11.1 Either party shall have the right to terminate this Agreement upon ninety (90) days' notice to the other, and the Corporation shall pay Employee until the date of termination, unless the Corporation terminates the Agreement because the Employee has violated either Articles 6, 7 or 8, in which case no additional compensation shall be payable to Employee. Employee acknowledges that any employment and compensation can be terminated with or without cause at any time by the Corporation, except as provided in Article 12. ARTICLE 12 TERMINATION UPON A CHANGE IN CONTROL 12.1 Notwithstanding Section 11.1, if a Change in Control occurs during the term of this Agreement, and if Employee's employment is terminated during the 12 month period following the date of the Change in Control (i) by the Corporation other than for Cause, death or Disability or (ii) by Employee for Good Reason, then Employee shall be entitled to a lump sum payment equal to two times the cash compensation paid to Employee in the year prior to termination and all outstanding options to purchase common stock held by Employee shall immediately become fully vested and exercisable. 12.2 For purposes of this Agreement, a "Change in Control" of the Corporation shall mean a change in control which would be required to be reported in response to Item 1 of Form 8-K promulgated under the Securities and Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Corporation is then subject to such reporting requirements including, without limitation, if: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes a "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing 40% or more of the combined voting power of the Corporation's then outstanding securities; or (ii) there ceases to be a majority of the Board of Directors comprised of: (A) individuals who on the date hereof constituted the Board of the Corporation; and (B) any new director who subsequently was elected or nominated for election by a majority of the directors who held such office immediately prior to a Change in Control. 12.3 Termination by the Corporation of Employee's employment for "Cause" during the 12 month period following a Change in Control shall mean termination due to: (i) gross neglect by Employee of his duties to the Corporation, or gross breach by Employee of the Corporation's reasonable policies that have been previously communicated to Employee, which in each case is not cured by Employee within 15 days after written notice by the Corporation to Employee describing the gross neglect or gross breach; (ii) the violation by Employee of Articles 6,7 or 8 of this Agreement; or (iii) the conviction of Employee by a court of competent jurisdiction of felony criminal conduct related to the conduct of business. 12.4 Employee shall be entitled to terminate his employment during the 12 month period following a Change in Control for Good Reason, which shall mean, without Employee's express written consent, any of the following: (i) a reduction by the Corporation in Employee's annual compensation in effect immediately prior to a Change in Control; (ii) the assignment to Employee of any duties inconsistent with Employee's status or position with the Corporation, or a substantial alteration in the nature or status of Employee's responsibilities from those in effect immediately prior to the Change in Control; (iii) the relocation of the Corporation's principal executive offices to a location more than fifty miles from their current location, or the Corporation requiring Employee to be based anywhere other than the Corporation's principal executive offices except for required travel on the Corporation's business to an extent substantially consistent with Employee's business travel obligations immediately prior to the Change in Control; (iv) the material reduction by the Corporation of the benefits enjoyed by Employee under any of the Corporation's pension, life insurance, medical, health and accident, disability, deferred compensation, incentive awards, incentive stock options, or savings plans in which Employee was participating immediately prior to the Change in Control, or the material reduction by the Corporation of any material fringe benefit enjoyed by Employee immediately prior to the Change in Control; (v) the failure of the Corporation to obtain a satisfactory agreement from any successor to assume and agree to perform this Agreement, as contemplated in Article 14; or (vi) any purported termination of Employee's employment which is not made pursuant to a Notice of Termination satisfying the requirements of Section 12.6 below. Notwithstanding the foregoing, unless the Employee gives a Notice of Termination satisfying the requirements of Section 12.6 below within 45 days of the occurrence of an event constituting Good Reason, the Employee shall have waived his rights under this Agreement for any benefits arising out of that event. 12.5 Termination by the Corporation of Employee's employment for "Disability" during the 12 month period following a Change of Control shall mean termination as a result of the Employee's incapacity due to physical or mental illness, which has caused the Employee to have been absent from the full-time performance of Employee's duties with the Corporation for five consecutive months, and within 30 days after written Notice of Termination is given the Employee shall not have returned to the full-time performance of the Employee's duties. 12.6 Any purported termination of Employee's employment by the Corporation or by Employee following a Change in Control shall be communicated by written Notice of Termination to the other party hereto and shall indicate the specific termination provision in this Agreement relied upon and shall set forth the facts and circumstances claimed to provide a basis for termination of Employee's employment under this Agreement. Notice of termination and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed to the last known residence address of the Employee or, in the case of the Corporation, to its principal office to the attention of the Chief Executive Officer of the Corporation with a copy to its Secretary, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. 12.7 If a determination is made by legislation, regulations, rulings directed to the Corporation or the Employee, or court decision that the aggregate amount of any payment made to the Employee hereunder, or pursuant to any plan, program or policy of the Corporation in connection with, on account of, or as a result of, a Change in Control constitutes "excess parachute payments" as defined in Section 280G of the Internal Revenue Code subject to the excise tax provisions of Section 4999 of the Code, or any successor sections thereof, the Employee shall be entitled to receive from the Corporation, in addition to any other amounts payable hereunder, an amount which shall be equal to such excise tax, plus, on a net after-tax basis, an amount equal to the aggregate amount of any interest, penalties, fines or additions to any tax, including income tax, which are imposed in connection with the imposition of such excise tax. Such amount shall be payable to the Employee as soon as may be practicable after such final determination is made. The Employee and the Corporation shall mutually and reasonably determine whether or not such determination has occurred or whether any appeal to such determination should be made. ARTICLE 13 CESSATION OF CORPORATE BUSINESS 13.1 This Agreement shall cease and terminate if the Corporation shall discontinue its business, and all rights and liabilities thereunder shall cease, except as provided in Article 14. ARTICLE 14 ASSIGNMENT 14.1 The Corporation shall have the right to assign this contract to its successors or assigns, and all covenants or agreements hereunder shall inure to the benefit of and be enforceable by or against its successors or assigns. 14.2 The terms "successors" and "assigns" shall include any corporation which buys all or substantially all of the Corporation's assets, or a controlling portion of its stock, or with which it merges or consolidates. ARTICLE 15 FAILURE TO DEMAND, PERFORMANCE AND WAIVER 15.1 The Corporation's failure to demand strict performance and compliance with any part of this Agreement during the Employee's employment shall not be deemed to be a waiver of the Corporation's rights under this Agreement or by operation of law. Any waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof. ARTICLE 16 ENTIRE AGREEMENT 16.1 The Corporation and Employee acknowledge that this Agreement contains the full and complete agreement between and among the parties, that there are no oral or implied agreements or other modifications not specifically set forth herein, and that this Agreement supersedes any prior agreements or understandings, if any, between the Corporation and Employee, whether written or oral. The parties further agree that no modifications of this Agreement may be made except by means of a written agreement or memorandum signed by the parties. ARTICLE 17 GOVERNING LAW 17.1 The parties acknowledge that the Corporation's principal place of business is located in the State of Minnesota, that this Agreement has been entered into in the State of Minnesota and that they wish legal certainty and predictability as to the terms of their undertaking. Accordingly, the parties hereby agree that this Agreement shall be construed in accordance with the laws of the State of Minnesota. IN WITNESS WHEREOF, the Corporation has hereunto signed its name and Employee hereunder has signed his name, all as of the day and year first-above written. CNS, INC. By /s/ Daniel E. Cohen ------------------------ Daniel E. Cohen, M.D. Chief Executive Officer EMPLOYEE /s/ Richard E. Jahnke ------------------------ Richard E. Jahnke EX-10.17 4 EMPLOYMENT AGREEMENT Exhibit 10.17 EMPLOYMENT AGREEMENT BETWEEN CNS, INC. AND KIRK P. HODGDON THIS AGREEMENT, made and entered into in the City of Bloomington, State of Minnesota, as of the 15th day of April, 1996, by and between CNS, Inc., a corporation duly organized and existing under the laws of the State of Delaware (the "Corporation") and Kirk P. Hodgdon ("Employee"); ARTICLE 1 EMPLOYMENT 1.1 The Corporation hereby employs Employee and Employee agrees to work for Corporation at such duties as are assigned to him from time to time by the directors and officers of the Corporation. ARTICLE 2 TERM 2.1 The term of this Agreement shall be for a period of one (1) year from the date hereof, unless sooner terminated as hereinafter provided. The Agreement shall thereafter continue in effect from year to year unless altered or terminated as hereinafter provided. ARTICLE 3 DUTIES 3.1 Employee agrees, unless otherwise specifically authorized by the Corporation, to devote his full time and effort to his duties for the profit, benefit and advantage of the business of the Corporation. ARTICLE 4 COMPENSATION 4.1 The Corporation agrees to pay Employee a salary of One Hundred Twenty Seven Thousand Dollars ($127,000) per year, payable bi-monthly, as adjusted from time to time by the Corporation's Board of Directors.; an automobile expense allowance of $500 per month; and other benefits as adopted from time to time. ARTICLE 5 INSURANCE 5.1 Employee agrees that the Corporation may, from time to time, apply for and take out in its own name and at its own expense, life, health, accident, or other insurance upon Employee that the Corporation may deem necessary or advisable to protect its interests hereunder; and Employee agrees to submit to any medical or other examination necessary for such purposes and to assist and cooperate with the Corporation in preparing such insurance; and Employee agrees that he shall have no right, title, or interest in or to such insurance. ARTICLE 6 NONCOMPETITION 6.1 The Corporation and the Employee acknowledge that: a. The Corporation's business is highly competitive; b. The essence of such business consists of confidential information and trade secrets as described in Article 7, all of which are zealously protected and kept secret by the Corporation; c. In the course of his employment, Employee will acquire the information described in Article 7 and that the Corporation would be adversely affected if such information subsequently, and in the event of the termination of the Employee's employment, is used for the purposes of competing with the Corporation; d. The Corporation markets its products throughout the United States; and e. For these reasons, both the Corporation and the Employee further acknowledge and agree that the restrictions contained herein are reasonable and necessary for the protection of their respective, legitimate interests. 6.2 Employee agrees that from and after the date hereof for the term of employment specified in Article 2 above and one (1) year after termination of his employment with the Corporation, he will not, without the express written permission of the Corporation, directly or indirectly own, manage, operate, control, lend money to, endorse the obligations of, or participate or be connected as an officer, 5% or more stockholder of a publicly-held company, stockholder of a closely-held company, employee, partner, or otherwise, with any enterprise or individual engaged in the business of developing, manufacturing or marketing products that have been, are being or are planned to be developed by the Corporation and will not in any manner, either directly or indirectly, compete with the Corporation in such business. It is understood and acknowledged by both parties that, inasmuch as the Corporation's products are marketed worldwide, this covenant not to compete shall be enforced throughout the United States and in any other country in which the Corporation is doing business as of the date of Employee's termination of employment and in any country for which the Corporation has developed or is in the process of developing a marketing plan for its products, even if such plan is not yet in effect. 6.3 Employee, during the term of his employment by the Corporation, shall at all times keep the Corporation informed of any business activity and outside employment, and shall not engage in any activity or employment which may be in conflict with the Corporation's interests. 6.4 If the Employee should breach any of the provisions of this Article 6, Corporation may enjoin him from continued breach, in addition to pursuing any other available legal and equitable remedies. ARTICLE 7 CONFIDENTIAL INFORMATION AND TRADE SECRETS 7.1 Employee has acquired and will acquire information and knowledge respecting the intimate and confidential affairs of the Corporation including, without limitation, confidential information with respect to the Corporation's products, packages, improvements, designs, practices, sales or distribution methods and other confidential information pertaining to the Corporation's business or financial affairs, which may or may not be patentable, which are developed by the Corporation at considerable time and expense, and which could be unfairly utilized in competition with the Corporation. The term "trade secret" shall be defined as follows: A trade secret may consist of any formula, pattern, device or compilation of information which is used in one's business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it. Accordingly, Employee agrees that he shall not, during the period of his employment hereunder or thereafter, use for his own benefit such confidential information or trade secrets acquired during the term of his employment by the Corporation. Further, during the period of his employment hereunder and thereafter, the Employee shall not, without the written consent of the Board of Directors of the Corporation or a person duly authorized thereby, disclose to any person, other than an employee of the Corporation or a person to whom disclosure is reasonably necessary or appropriate in connection with the performance by the Employee of his duties, any confidential information or trade secrets obtained by him while in the employ of the Corporation. 7.2 Upon termination of employment, Employee agrees to deliver to the Corporation all materials that include confidential information or trade secrets, such as customer lists, product formulations, instruction sheets, drawings, manuals, letters, notes, notebooks, books, reports and copies thereof, and all other materials of a confidential nature which belong to or relate to the business of the Corporation. ARTICLE 8 IMPROVEMENTS AND INVENTIONS 8.1 Employee shall promptly and fully disclose to the Corporation, any and all ideas, improvements, discoveries and inventions, whether or not they are believed to be patentable (all of which are hereinafter referred to as "Inventions"), which Employee conceives or first actually reduces to practice, either solely or jointly with others, during the period of Employee's employment or within two years after termination of employment, and which relate to the business now or hereafter carried on or presently part of the business plan of the Corporation or which results from any work performed by Employee for the Corporation. 8.2 All such Inventions shall be the sole and exclusive property of the Corporation, and during the term of his employment and thereafter, whenever requested to do so by the Corporation, Employee shall execute and assign any and all applications, assignments and other instruments which the Corporation shall deem necessary or convenient in order to apply for and obtain Letters Patent of the United States and/or of any foreign countries for such Inventions and in order to assign and convey to the Corporation or its nominee the sole and exclusive right, title and interest in and to such Inventions, and Employee will render aid and assistance in any interference or litigation pertaining thereto, all expenses reasonably incurred by Employee at the request of the Corporation shall be borne by the Corporation. 8.3 To the extent, if any, that Minnesota law is determined to apply to the enforceability of this Agreement, Minnesota Statute Section 181.78 provides that the Agreement does not apply, and written notification is hereby given to the Employee that this Agreement does not apply, to an Invention for which no equipment, supplies, facility or trade secret information of the Corporation was used and which was developed entirely on the Employee's own time, and (1) which does not relate (a) directly to the business of the Corporation, or (b) to the Corporation's actual or demonstrably anticipated research or development, or (2) which does not result from any work performed by the Employee for the Corporation. ARTICLE 9 JUDICIAL CONSTRUCTION 9.1 The Employee believes and acknowledges that the provisions contained in this Agreement, including the covenants contained in Articles 6, 7 and 8 of this Agreement, are fair and reasonable. Nonetheless, it is agreed that if a court finds any of these provisions to be invalid in whole or in part under the laws of any state, such finding shall not invalidate the covenants, nor the Agreement in its entirety, but rather the covenants shall be construed and/or blue-lined, reformed or rewritten by the court as if the most restrictive covenants permissible under applicable law were contained herein. ARTICLE 10 RIGHT TO INJUNCTIVE RELIEF 10.1 Employee acknowledges that a breach by the Employee of any of the terms of Articles 6, 7, or 8 of this Agreement will render irreparable harm to the Corporation; and that the Corporation shall therefore be entitled to any and all equitable relief, including, but not limited to, injunctive relief, and to any other remedy that may be available under any applicable law or agreement between the parties, and to recover from the Employee all costs of litigation including, but not limited to, attorneys' fees and court costs. ARTICLE 11 TERMINATION 11.1 Either party shall have the right to terminate this Agreement upon ninety (90) days' notice to the other, and the Corporation shall pay Employee until the date of termination, unless the Corporation terminates the Agreement because the Employee has violated either Articles 6, 7 or 8, in which case no additional compensation shall be payable to Employee. Employee acknowledges that any employment and compensation can be terminated with or without cause at any time by the Corporation, except as provided in Article 12. ARTICLE 12 TERMINATION UPON A CHANGE IN CONTROL 12.1 Notwithstanding Section 11.1, if a Change in Control occurs during the term of this Agreement, and if Employee's employment is terminated during the 12 month period following the date of the Change in Control (i) by the Corporation other than for Cause, death or Disability or (ii) by Employee for Good Reason, then Employee shall be entitled to a lump sum payment equal to two times the cash compensation paid to Employee in the year prior to termination and all outstanding options to purchase common stock held by Employee shall immediately become fully vested and exercisable. 12.2 For purposes of this Agreement, a "Change in Control" of the Corporation shall mean a change in control which would be required to be reported in response to Item 1 of Form 8-K promulgated under the Securities and Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Corporation is then subject to such reporting requirements including, without limitation, if: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes a "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing 40% or more of the combined voting power of the Corporation's then outstanding securities; or (ii) there ceases to be a majority of the Board of Directors comprised of: (A) individuals who on the date hereof constituted the Board of the Corporation; and (B) any new director who subsequently was elected or nominated for election by a majority of the directors who held such office immediately prior to a Change in Control. 12.3 Termination by the Corporation of Employee's employment for "Cause" during the 12 month period following a Change in Control shall mean termination due to: (i) gross neglect by Employee of his duties to the Corporation, or gross breach by Employee of the Corporation's reasonable policies that have been previously communicated to Employee, which in each case is not cured by Employee within 15 days after written notice by the Corporation to Employee describing the gross neglect or gross breach; (ii) the violation by Employee of Articles 6,7 or 8 of this Agreement; or (iii) the conviction of Employee by a court of competent jurisdiction of felony criminal conduct related to the conduct of business. 12.4 Employee shall be entitled to terminate his employment during the 12 month period following a Change in Control for Good Reason, which shall mean, without Employee's express written consent, any of the following: (i) a reduction by the Corporation in Employee's annual compensation in effect immediately prior to a Change in Control; (ii) the assignment to Employee of any duties inconsistent with Employee's status or position with the Corporation, or a substantial alteration in the nature or status of Employee's responsibilities from those in effect immediately prior to the Change in Control; (iii) the relocation of the Corporation's principal executive offices to a location more than fifty miles from their current location, or the Corporation requiring Employee to be based anywhere other than the Corporation's principal executive offices except for required travel on the Corporation's business to an extent substantially consistent with Employee's business travel obligations immediately prior to the Change in Control; (iv) the material reduction by the Corporation of the benefits enjoyed by Employee under any of the Corporation's pension, life insurance, medical, health and accident, disability, deferred compensation, incentive awards, incentive stock options, or savings plans in which Employee was participating immediately prior to the Change in Control, or the material reduction by the Corporation of any material fringe benefit enjoyed by Employee immediately prior to the Change in Control; (v) the failure of the Corporation to obtain a satisfactory agreement from any successor to assume and agree to perform this Agreement, as contemplated in Article 14; or (vi) any purported termination of Employee's employment which is not made pursuant to a Notice of Termination satisfying the requirements of Section 12.6 below. Notwithstanding the foregoing, unless the Employee gives a Notice of Termination satisfying the requirements of Section 12.6 below within 45 days of the occurrence of an event constituting Good Reason, the Employee shall have waived his rights under this Agreement for any benefits arising out of that event. 12.5 Termination by the Corporation of Employee's employment for "Disability" during the 12 month period following a Change of Control shall mean termination as a result of the Employee's incapacity due to physical or mental illness, which has caused the Employee to have been absent from the full-time performance of Employee's duties with the Corporation for five consecutive months, and within 30 days after written Notice of Termination is given the Employee shall not have returned to the full-time performance of the Employee's duties. 12.6 Any purported termination of Employee's employment by the Corporation or by Employee following a Change in Control shall be communicated by written Notice of Termination to the other party hereto and shall indicate the specific termination provision in this Agreement relied upon and shall set forth the facts and circumstances claimed to provide a basis for termination of Employee's employment under this Agreement. Notice of termination and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed to the last known residence address of the Employee or, in the case of the Corporation, to its principal office to the attention of the President of the Corporation with a copy to its Secretary, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. 12.7 If a determination is made by legislation, regulations, rulings directed to the Corporation or the Employee, or court decision that the aggregate amount of any payment made to the Employee hereunder, or pursuant to any plan, program or policy of the Corporation in connection with, on account of, or as a result of, a Change in Control constitutes "excess parachute payments" as defined in Section 280G of the Internal Revenue Code subject to the excise tax provisions of Section 4999 of the Code, or any successor sections thereof, the Employee shall be entitled to receive from the Corporation, in addition to any other amounts payable hereunder, an amount which shall be equal to such excise tax, plus, on a net after-tax basis, an amount equal to the aggregate amount of any interest, penalties, fines or additions to any tax, including income tax, which are imposed in connection with the imposition of such excise tax. Such amount shall be payable to the Employee as soon as may be practicable after such final determination is made. The Employee and the Corporation shall mutually and reasonably determine whether or not such determination has occurred or whether any appeal to such determination should be made. ARTICLE 13 CESSATION OF CORPORATE BUSINESS 13.1 This Agreement shall cease and terminate if the Corporation shall discontinue its business, and all rights and liabilities thereunder shall cease, except as provided in Article 14. ARTICLE 14 ASSIGNMENT 14.1 The Corporation shall have the right to assign this contract to its successors or assigns, and all covenants or agreements hereunder shall inure to the benefit of and be enforceable by or against its successors or assigns. 14.2 The terms "successors" and "assigns" shall include any corporation which buys all or substantially all of the Corporation's assets, or a controlling portion of its stock, or with which it merges or consolidates. ARTICLE 15 FAILURE TO DEMAND, PERFORMANCE AND WAIVER 15.1 The Corporation's failure to demand strict performance and compliance with any part of this Agreement during the Employee's employment shall not be deemed to be a waiver of the Corporation's rights under this Agreement or by operation of law. Any waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof. ARTICLE 16 ENTIRE AGREEMENT 16.1 The Corporation and Employee acknowledge that this Agreement contains the full and complete agreement between and among the parties, that there are no oral or implied agreements or other modifications not specifically set forth herein, and that this Agreement supersedes any prior agreements or understandings, if any, between the Corporation and Employee, whether written or oral. The parties further agree that no modifications of this Agreement may be made except by means of a written agreement or memorandum signed by the parties. ARTICLE 17 GOVERNING LAW 17.1 The parties acknowledge that the Corporation's principal place of business is located in the State of Minnesota, that this Agreement has been entered into in the State of Minnesota and that they wish legal certainty and predictability as to the terms of their undertaking. Accordingly, the parties hereby agree that this Agreement shall be construed in accordance with the laws of the State of Minnesota. IN WITNESS WHEREOF, the Corporation has hereunto signed its name and Employee hereunder has signed his name, all as of the day and year first-above written. CNS, INC. By /s/ Daniel E. Cohen ------------------------ Daniel E. Cohen, M.D. Chief Executive Officer EMPLOYEE /s/ Kirk P. Hodgdon ------------------------ Kirk P. Hodgdon EX-10.18 5 EMPLOYMENT AGREEMENT Exhibit 10.18 EMPLOYMENT AGREEMENT BETWEEN CNS, INC. AND DAVID J. BYRD THIS AGREEMENT, made and entered into in the City of Bloomington, State of Minnesota, as of the 15th day of April, 1996, by and between CNS, Inc., a corporation duly organized and existing under the laws of the State of Delaware (the "Corporation") and David J. Byrd ("Employee"); ARTICLE 1 EMPLOYMENT 1.1 The Corporation hereby employs Employee and Employee agrees to work for Corporation at such duties as are assigned to him from time to time by the directors and officers of the Corporation. ARTICLE 2 TERM 2.1 The term of this Agreement shall be for a period of one (1) year from the date hereof (compensation commencing February 5, 1996), unless sooner terminated as hereinafter provided. The Agreement shall thereafter continue in effect from year to year unless altered or terminated as hereinafter provided. ARTICLE 3 DUTIES 3.1 Employee agrees, unless otherwise specifically authorized by the Corporation, to devote his full time and effort to his duties for the profit, benefit and advantage of the business of the Corporation. ARTICLE 4 COMPENSATION 4.1 The Corporation agrees to pay Employee a salary of One Hundred Thirty Thousand Dollars ($130,000) per year, payable bi-monthly, as adjusted from time to time by the Corporation's Board of Directors; and other benefits as adopted from time to time by the Corporation. In addition, Employee may earn cash bonus amounts as established by the Board of Directors from time to time. ARTICLE 5 INSURANCE 5.1 Employee agrees that the Corporation may, from time to time, apply for and take out in its own name and at its own expense, life, health, accident, or other insurance upon Employee that the Corporation may deem necessary or advisable to protect its interests hereunder; and Employee agrees to submit to any medical or other examination necessary for such purposes and to assist and cooperate with the Corporation in preparing such insurance; and Employee agrees that he shall have no right, title, or interest in or to such insurance. ARTICLE 6 NONCOMPETITION 6.1 The Corporation and the Employee acknowledge that: a. The Corporation's business is highly competitive; b. The essence of such business consists of confidential information and trade secrets as described in Article 7, all of which are zealously protected and kept secret by the Corporation; c. In the course of his employment, Employee will acquire the information described in Article 7 and that the Corporation would be adversely affected if such information subsequently, and in the event of the termination of the Employee's employment, is used for the purposes of competing with the Corporation; d. The Corporation markets its products throughout the United States; and e. For these reasons, both the Corporation and the Employee further acknowledge and agree that the restrictions contained herein are reasonable and necessary for the protection of their respective, legitimate interests. 6.2 Employee agrees that from and after the date hereof for the term of employment specified in Article 2 above and one (1) year after termination of his employment with the Corporation, he will not, without the express written permission of the Corporation, directly or indirectly own, manage, operate, control, lend money to, endorse the obligations of, or participate or be connected as an officer, 5% or more stockholder of a publicly-held company, stockholder of a closely-held company, employee, partner, or otherwise, with any enterprise or individual engaged in the business of developing, manufacturing or marketing products that have been, are being or are planned to be developed by the Corporation and will not in any manner, either directly or indirectly, compete with the Corporation in such business. It is understood and acknowledged by both parties that, inasmuch as the Corporation's products are marketed worldwide, this covenant not to compete shall be enforced throughout the United States and in any other country in which the Corporation is doing business as of the date of Employee's termination of employment and in any country for which the Corporation has developed or is in the process of developing a marketing plan for its products, even if such plan is not yet in effect. 6.3 Employee, during the term of his employment by the Corporation, shall at all times keep the Corporation informed of any business activity and outside employment, and shall not engage in any activity or employment which may be in conflict with the Corporation's interests. 6.4 If the Employee should breach any of the provisions of this Article 6, Corporation may enjoin him from continued breach, in addition to pursuing any other available legal and equitable remedies. ARTICLE 7 CONFIDENTIAL INFORMATION AND TRADE SECRETS 7.1 Employee has acquired and will acquire information and knowledge respecting the intimate and confidential affairs of the Corporation including, without limitation, confidential information with respect to the Corporation's products, packages, improvements, designs, practices, sales or distribution methods and other confidential information pertaining to the Corporation's business or financial affairs, which may or may not be patentable, which are developed by the Corporation at considerable time and expense, and which could be unfairly utilized in competition with the Corporation. The term "trade secret" shall be defined as follows: A trade secret may consist of any formula, pattern, device or compilation of information which is used in one's business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it. Accordingly, Employee agrees that he shall not, during the period of his employment hereunder or thereafter, use for his own benefit such confidential information or trade secrets acquired during the term of his employment by the Corporation. Further, during the period of his employment hereunder and thereafter, the Employee shall not, without the written consent of the Board of Directors of the Corporation or a person duly authorized thereby, disclose to any person, other than an employee of the Corporation or a person to whom disclosure is reasonably necessary or appropriate in connection with the performance by the Employee of his duties, any confidential information or trade secrets obtained by him while in the employ of the Corporation. 7.2 Upon termination of employment, Employee agrees to deliver to the Corporation all materials that include confidential information or trade secrets, such as customer lists, product formulations, instruction sheets, drawings, manuals, letters, notes, notebooks, books, reports and copies thereof, and all other materials of a confidential nature which belong to or relate to the business of the Corporation. ARTICLE 8 IMPROVEMENTS AND INVENTIONS 8.1 Employee shall promptly and fully disclose to the Corporation, any and all ideas, improvements, discoveries and inventions, whether or not they are believed to be patentable (all of which are hereinafter referred to as "Inventions"), which Employee conceives or first actually reduces to practice, either solely or jointly with others, during the period of Employee's employment or within two years after termination of employment, and which relate to the business now or hereafter carried on or presently part of the business plan of the Corporation or which results from any work performed by Employee for the Corporation. 8.2 All such Inventions shall be the sole and exclusive property of the Corporation, and during the term of his employment and thereafter, whenever requested to do so by the Corporation, Employee shall execute and assign any and all applications, assignments and other instruments which the Corporation shall deem necessary or convenient in order to apply for and obtain Letters Patent of the United States and/or of any foreign countries for such Inventions and in order to assign and convey to the Corporation or its nominee the sole and exclusive right, title and interest in and to such Inventions, and Employee will render aid and assistance in any interference or litigation pertaining thereto, all expenses reasonably incurred by Employee at the request of the Corporation shall be borne by the Corporation. 8.3 To the extent, if any, that Minnesota law is determined to apply to the enforceability of this Agreement, Minnesota Statute Section 181.78 provides that the Agreement does not apply, and written notification is hereby given to the Employee that this Agreement does not apply, to an Invention for which no equipment, supplies, facility or trade secret information of the Corporation was used and which was developed entirely on the Employee's own time, and (1) which does not relate (a) directly to the business of the Corporation, or (b) to the Corporation's actual or demonstrably anticipated research or development, or (2) which does not result from any work performed by the Employee for the Corporation. ARTICLE 9 JUDICIAL CONSTRUCTION 9.1 The Employee believes and acknowledges that the provisions contained in this Agreement, including the covenants contained in Articles 6, 7 and 8 of this Agreement, are fair and reasonable. Nonetheless, it is agreed that if a court finds any of these provisions to be invalid in whole or in part under the laws of any state, such finding shall not invalidate the covenants, nor the Agreement in its entirety, but rather the covenants shall be construed and/or blue-lined, reformed or rewritten by the court as if the most restrictive covenants permissible under applicable law were contained herein. ARTICLE 10 RIGHT TO INJUNCTIVE RELIEF 10.1 Employee acknowledges that a breach by the Employee of any of the terms of Articles 6, 7, or 8 of this Agreement will render irreparable harm to the Corporation; and that the Corporation shall therefore be entitled to any and all equitable relief, including, but not limited to, injunctive relief, and to any other remedy that may be available under any applicable law or agreement between the parties, and to recover from the Employee all costs of litigation including, but not limited to, attorneys' fees and court costs. ARTICLE 11 TERMINATION 11.1 Either party shall have the right to terminate this Agreement upon ninety (90) days' notice to the other, and the Corporation shall pay Employee until the date of termination, unless the Corporation terminates the Agreement because the Employee has violated either Articles 6, 7 or 8, in which case no additional compensation shall be payable to Employee. Employee acknowledges that any employment and compensation can be terminated with or without cause at any time by the Corporation, except as provided in Article 12. ARTICLE 12 TERMINATION UPON A CHANGE IN CONTROL 12.1 Notwithstanding Section 11.1, if a Change in Control occurs during the term of this Agreement, and if Employee's employment is terminated during the 12 month period following the date of the Change in Control (i) by the Corporation other than for Cause, death or Disability or (ii) by Employee for Good Reason, then Employee shall be entitled to a lump sum payment equal to two times the cash compensation paid to Employee in the year prior to termination and all outstanding options to purchase common stock held by Employee shall immediately become fully vested and exercisable. 12.2 For purposes of this Agreement, a "Change in Control" of the Corporation shall mean a change in control which would be required to be reported in response to Item 1 of Form 8-K promulgated under the Securities and Exchange Act of 1934, as amended (the "Exchange Act"), whether or not the Corporation is then subject to such reporting requirements including, without limitation, if: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) becomes a "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing 40% or more of the combined voting power of the Corporation's then outstanding securities; or (ii) there ceases to be a majority of the Board of Directors comprised of: (A) individuals who on the date hereof constituted the Board of the Corporation; and (B) any new director who subsequently was elected or nominated for election by a majority of the directors who held such office immediately prior to a Change in Control. 12.3 Termination by the Corporation of Employee's employment for "Cause" during the 12 month period following a Change in Control shall mean termination due to: (i) gross neglect by Employee of his duties to the Corporation, or gross breach by Employee of the Corporation's reasonable policies that have been previously communicated to Employee, which in each case is not cured by Employee within 15 days after written notice by the Corporation to Employee describing the gross neglect or gross breach; (ii) the violation by Employee of Articles 6,7 or 8 of this Agreement; or (iii) the conviction of Employee by a court of competent jurisdiction of felony criminal conduct related to the conduct of business. 12.4 Employee shall be entitled to terminate his employment during the 12 month period following a Change in Control for Good Reason, which shall mean, without Employee's express written consent, any of the following: (i) a reduction by the Corporation in Employee's annual compensation in effect immediately prior to a Change in Control; (ii) the assignment to Employee of any duties inconsistent with Employee's status or position with the Corporation, or a substantial alteration in the nature or status of Employee's responsibilities from those in effect immediately prior to the Change in Control; (iii) the relocation of the Corporation's principal executive offices to a location more than fifty miles from their current location, or the Corporation requiring Employee to be based anywhere other than the Corporation's principal executive offices except for required travel on the Corporation's business to an extent substantially consistent with Employee's business travel obligations immediately prior to the Change in Control; (iv) the material reduction by the Corporation of the benefits enjoyed by Employee under any of the Corporation's pension, life insurance, medical, health and accident, disability, deferred compensation, incentive awards, incentive stock options, or savings plans in which Employee was participating immediately prior to the Change in Control, or the material reduction by the Corporation of any material fringe benefit enjoyed by Employee immediately prior to the Change in Control; (v) the failure of the Corporation to obtain a satisfactory agreement from any successor to assume and agree to perform this Agreement, as contemplated in Article 14; or (vi) any purported termination of Employee's employment which is not made pursuant to a Notice of Termination satisfying the requirements of Section 12.6 below. Notwithstanding the foregoing, unless the Employee gives a Notice of Termination satisfying the requirements of Section 12.6 below within 45 days of the occurrence of an event constituting Good Reason, the Employee shall have waived his rights under this Agreement for any benefits arising out of that event. 12.5 Termination by the Corporation of Employee's employment for "Disability" during the 12 month period following a Change of Control shall mean termination as a result of the Employee's incapacity due to physical or mental illness, which has caused the Employee to have been absent from the full-time performance of Employee's duties with the Corporation for five consecutive months, and within 30 days after written Notice of Termination is given the Employee shall not have returned to the full-time performance of the Employee's duties. 12.6 Any purported termination of Employee's employment by the Corporation or by Employee following a Change in Control shall be communicated by written Notice of Termination to the other party hereto and shall indicate the specific termination provision in this Agreement relied upon and shall set forth the facts and circumstances claimed to provide a basis for termination of Employee's employment under this Agreement. Notice of termination and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered or certified mail, return receipt requested, postage prepaid, addressed to the last known residence address of the Employee or, in the case of the Corporation, to its principal office to the attention of the President of the Corporation with a copy to its Secretary, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. 12.7 If a determination is made by legislation, regulations, rulings directed to the Corporation or the Employee, or court decision that the aggregate amount of any payment made to the Employee hereunder, or pursuant to any plan, program or policy of the Corporation in connection with, on account of, or as a result of, a Change in Control constitutes "excess parachute payments" as defined in Section 280G of the Internal Revenue Code subject to the excise tax provisions of Section 4999 of the Code, or any successor sections thereof, the Employee shall be entitled to receive from the Corporation, in addition to any other amounts payable hereunder, an amount which shall be equal to such excise tax, plus, on a net after-tax basis, an amount equal to the aggregate amount of any interest, penalties, fines or additions to any tax, including income tax, which are imposed in connection with the imposition of such excise tax. Such amount shall be payable to the Employee as soon as may be practicable after such final determination is made. The Employee and the Corporation shall mutually and reasonably determine whether or not such determination has occurred or whether any appeal to such determination should be made. ARTICLE 13 CESSATION OF CORPORATE BUSINESS 13.1 This Agreement shall cease and terminate if the Corporation shall discontinue its business, and all rights and liabilities thereunder shall cease, except as provided in Article 14. ARTICLE 14 ASSIGNMENT 14.1 The Corporation shall have the right to assign this contract to its successors or assigns, and all covenants or agreements hereunder shall inure to the benefit of and be enforceable by or against its successors or assigns. 14.2 The terms "successors" and "assigns" shall include any corporation which buys all or substantially all of the Corporation's assets, or a controlling portion of its stock, or with which it merges or consolidates. ARTICLE 15 FAILURE TO DEMAND, PERFORMANCE AND WAIVER 15.1 The Corporation's failure to demand strict performance and compliance with any part of this Agreement during the Employee's employment shall not be deemed to be a waiver of the Corporation's rights under this Agreement or by operation of law. Any waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed as a waiver of any subsequent breach thereof. ARTICLE 16 ENTIRE AGREEMENT 16.1 The Corporation and Employee acknowledge that this Agreement contains the full and complete agreement between and among the parties, that there are no oral or implied agreements or other modifications not specifically set forth herein, and that this Agreement supersedes any prior agreements or understandings, if any, between the Corporation and Employee, whether written or oral. The parties further agree that no modifications of this Agreement may be made except by means of a written agreement or memorandum signed by the parties. ARTICLE 17 GOVERNING LAW 17.1 The parties acknowledge that the Corporation's principal place of business is located in the State of Minnesota, that this Agreement has been entered into in the State of Minnesota and that they wish legal certainty and predictability as to the terms of their undertaking. Accordingly, the parties hereby agree that this Agreement shall be construed in accordance with the laws of the State of Minnesota. IN WITNESS WHEREOF, the Corporation has hereunto signed its name and Employee hereunder has signed his name, all as of the day and year first-above written. CNS, INC. By /s/ Daniel E. Cohen ------------------------ Daniel E. Cohen, M.D. Chief Executive Officer EMPLOYEE /s/ David J. Byrd ------------------------ David J. Byrd EX-11.1 6 COMPUTATION OF NET EARNINGS EXHIBIT 11.1
CNS, INC. COMPUTATION OF NET EARNINGS (LOSS) PER SHARE OF COMMON STOCK Year Ended December 31, ------------------------------------------ 1996 1995 1994 ------------ ------------ ------------ NET INCOME (LOSS): Income (loss) from continuing operations ....................... $ 15,522,484 $ 13,310,505 $ (2,558,101) Income from discontinued operations ... 0 765,989 (309,314) ------------ ------------ ------------ Net income (loss) ..................... $ 15,522,484 $ 14,076,494 $ (2,867,415) ============ ============ ============ PRIMARY EARNINGS PER SHARE: Average number of common and common equivalent shares outstanding Average common shares outstanding 18,704,000 17,221,000 15,755,000 Incentive stock options .......... 636,000 663,000 0 Non-qualified stock options ...... 392,000 392,000 0 Warrants ......................... 75,000 70,000 0 ------------ ------------ ------------ 19,807,000 18,346,000 15,755,000 ============ ============ ============ Earnings per share from continuing operations ....................... $ .78 $ .73 $ (.16) Earnings per share from discontinued operations ....................... 0 .04 (.02) ------------ ------------ ------------ Primary earnings (loss) per share ..... $ .78 $ .77 $ (.18) ============ ============ ============ FULLY DILUTED EARNINGS PER SHARE: Average number of common and common equivalent shares outstanding Average common shares outstanding 18,704,000 17,221,000 15,755,000 Incentive stock options .......... 636,000 680,000 0 Non-qualified stock options ...... 392,000 403,000 0 Warrants ......................... 75,000 72,000 0 ------------ ------------ ------------ 19,807,000 18,376,000 15,755,000 ============ ============ ============ Earnings per share from continuing operations ....................... $ .78 $ .72 $ (.16) Earnings per share from discontinued operations ....................... 0 .04 (.02) ------------ ------------ ------------ Fully diluted earnings (loss) per share $ .78 $ .76 $ (.18) ============ ============ ============
EX-13 7 FINANCIAL HIGHLIGHTS Financial Highlights [PHOTO]
Years ended December 31, 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------------------------------------------- Results of Operations(1)(2): Net sales $ 85,866,525 $ 48,631,855 $ 2,798,174 $ 93,352 $ 0 Gross profit 52,519,647 31,077,442 1,008,629 44,840 0 Operating income (loss) 21,742,602 12,398,086 (2,757,636) (395,554) 0 Income (loss) from continuing operations before income taxes 24,022,484 12,969,505 (2,558,101) (298,753) 0 Income (loss) from continuing operations 15,522,484 13,310,505 (2,558,101) (298,753) 0 Net income (loss) 15,522,484 14,076,494 (2,867,415) (1,430,773) (808,169) Net income (loss) per common and common equivalent share: From continuing operations $ .78 $ 0.72 $ (0.16) $ (0.02) $ 0.00 From discontinued operations .00 0.04 (0.02) (0.09) (0.07) -------------------------------------------------------------------------- Net income (loss) per share $ .78 $ 0.76 $ (0.18) $ (0.11) $ (0.07) ========================================================================== Weighted average number of common and common equivalent shares outstanding 19,807,000 18,376,000 15,755,000 13,145,000 12,276,000 December 31, 1996 1995 1994 1993 1992 - -------------------------------------------------------------------------------------------------------------------------- Financial Position(1): Working capital $ 78,402,795 $ 25,855,456 $ 10,790,457 $ 3,716,040 $ 5,200,527 Total assets 89,409,067 32,340,535 11,612,871 3,871,506 5,200,527 Stockholders' equity 79,774,907 26,885,342 11,206,535 3,871,506 5,200,527
(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. In 1995, the Company focused on the Breathe Right nasal strip and divested itself of the assets related to its sleep disorders business. Unless otherwise noted, the following discussion of financial condition and results of operations relate only to continuing operations of the Company. The Company's revenues are derived primarily from the manufacture and sale of the Breathe Right nasal strip. Revenue from sales is recognized when earned, generally at the time products are shipped. The Company obtained the license to manufacture and sell the Breathe Right nasal strip in 1992 and received FDA clearance in October 1993 to market the Breathe Right nasal strip as a product which improves nasal breathing. In September 1994, the Company launched its consumer marketing program which was enhanced by broad media coverage of the use of Breathe Right nasal strips by professional football players. At the same time, a number of radio and television personalities provided unsolicited endorsements of the product on national radio and television. 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.
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 operations for the periods indicated. Three Months Ended 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 Other income, net 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 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 Other income, net 0.7 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% ============================================ 8
Three Months Ended 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 Other income, net 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 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 Other income, net 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% ====================================================
Three Months Ended Year Ended - -------------------------------------------------------------------------------- Mar 31, Jun 30, Sep 30, Dec 31, Dec 31, 1994 1994 1994 1994 1994 - -------------------------------------------------------------------------------------------- (In thousands) Domestic net sales $ 344 $ 529 $ 682 $ 1,243 $ 2,798 International net sales 0 0 0 0 0 -------------------------------------------------------- Net sales 344 529 682 1,243 2,798 Cost of goods sold 248 364 368 809 1,790 -------------------------------------------------------- Gross profit 96 165 314 434 1,008 -------------------------------------------------------- Operating expenses: Marketing and selling 387 517 839 1,357 3,100 General and administrative 140 182 184 160 666 Product development 0 0 0 0 0 -------------------------------------------------------- Total operating expenses 527 699 1,023 1,517 3,766 -------------------------------------------------------- Operating income (431) (534) (709) (1,083) (2,758) Other income, net (3) 60 78 64 200 -------------------------------------------------------- Income from continuing operations before income taxes $ (434) $ (474) $ (631) $(1,019) $(2,558) ======================================================== Three Months Ended Year Ended - -------------------------------------------------------------------------------- Mar 31, Jun 30, Sep 30, Dec 31, Dec 31, 1994 1994 1994 1994 1994 - -------------------------------------------------------------------------------------------- Net sales 100.0% 100.0% 100.0% 100.0% 100.0% Cost of goods sold 72.1 68.8 54.0 65.1 63.9 -------------------------------------------------------- Gross profit 27.9 31.2 46.0 34.9 36.1 -------------------------------------------------------- Operating expenses: Marketing and selling 112.5 97.7 123.0 109.1 110.8 General and administrative 40.7 34.4 27.0 12.9 23.8 Product development .0 .0 .0 .0 .0 -------------------------------------------------------- Total operating expenses 153.2 132.1 150.0 122.0 134.6 -------------------------------------------------------- Operating income (125.3) (100.9) (104.0) (87.1) (98.5) Other income, net (.9) 11.3 11.5 5.1 7.1 -------------------------------------------------------- Income from continuing operations before income taxes (126.2)% (89.6)% (92.5)% (82.0)% (91.4)% ========================================================
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. 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. 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 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. As a result, the Company does not expect that the quarterly international sales patterns for 1997 will be directly comparable to the quarters of 1996. 9 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. 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 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. 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 $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, NET. Interest income, net was $2.3 million for 1996 compared to $571,000 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. 1995 COMPARED TO 1994 NET SALES. Net sales increased to $48.6 million for 1995 from $2.8 million for 1994. Breathe Right nasal strip sales increased as a result of expanded consumer advertising and an increase in the number of retail outlets selling the product. In the first quarter of 1995, a rapid increase in demand for the product resulted in the Company being unable to avoid large back orders and out of stock situations. As a result, net sales for the three months ended June 30, 1995 included approximately $7 million of back orders received in the prior quarter. The Company believes that much of the product sold during the nine months ended September 30, 1995 represented an increase in inventory levels at existing and new retail outlets and initial stocking of inventory of additional box and size configurations of the product. GROSS PROFIT. Gross profit was $31.1 million for 1995 compared to $1.0 million for 1994. Gross profit as a percentage of net sales improved to 63.9% for 1995 compared to 36.1% for 1994, primarily as a result of efficiencies realized from the higher level of Breathe Right nasal strip sales and cost reduction programs initiated by the Company. MARKETING AND SELLING EXPENSES. Marketing and selling expenses were $16.7 million for 1995 compared to $3.1 million for 1994. This increase resulted primarily from the marketing expenses associated with a full year of consumer advertising for the Breathe Right nasal strip. Marketing and selling expenses as a percentage of net sales decreased to 34.3% in 1995 from 110.8% in 1994 as a result of the higher level of sales. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were $1.9 million for 1995 compared to $666,000 for 1994. This increase resulted from the additional personnel and systems required to support growth of the Breathe Right nasal strip business. General and administrative expenses as a percentage of net sales decreased to 4.0% in 1995 from 23.8% in 1994 primarily as a result of the higher level of sales. INTEREST INCOME, NET. Interest income, net was $571,000 for 1995 compared to $200,000 for 1994, resulting from investment of funds from the sale of the Company's sleep disorder diagnostic products business. INCOME TAX BENEFIT. The income tax benefit for 1995 of $341,000 resulted from the recognition of the benefit of net operating losses and credit carry forwards from prior years by the elimination of the valuation allowance on deferred tax assets due to the Company's expected future taxable income. SEASONALITY The Company believes that approximately 50 percent of Breathe Right nasal strip users currently use the product for the temporary relief of nasal congestion. 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 of 1996. 10 LIQUIDITY AND CAPITAL RESOURCES At December 31, 1996, the Company had cash, cash equivalents and marketable securities of $62.4 million and working capital of $78.4 million. OPERATING ACTIVITIES. The Company provided cash from operations of approximately $16.4 million for 1996 compared to a use of cash of $1.5 million for 1995. The improved cash flow was primarily due to an increase in income from continuing operations plus a reduction in inventories and an increase in current liabilities, offset by an increase in accounts receivable resulting from higher sales levels. INVESTING ACTIVITIES. The Company purchased, net of sales and maturities, marketable securities of $42.4 million in 1996 with net proceeds from the public offering of common stock and cash provided from operations, compared to net purchases of $2.9 million in 1995. Marketable securities purchased consisted of commercial paper, corporate bonds, U.S. Government obligations and municipal bonds. The Company purchased $465,000 of property and equipment in 1996 compared to $384,000 in 1995 to support increases in sales of the Breathe Right nasal strip. Capitalized patent and trademark costs were $141,000 in 1996 compared to $73,000 in 1994. The Company currently expects to spend up to an aggregate of $7.5 million on capital expenditures in 1997 and 1998 in order to among other things supplement its in-house manufacturing capability and to expand and upgrade management information systems. The final amount of the expenditures as well as the timing of the expenditures may be subject to change. FINANCING ACTIVITIES. 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 intends to use the net proceeds to provide working capital; to finance certain supplementary in-house manufacturing capability; to expand and upgrade management information systems; and for other general corporate purposes, including the possible future acquisition of products that would compliment our existing operations. 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. RECENT ACCOUNTING PRONOUNCEMENTS In October 1995, the Financial Accounting Standards Board issued Statement No. 123, Accounting for Stock-Based Compensation. In 1996, the Company adopted the disclosure provisions of this Statement while continuing to account for options and other stock-based compensation using Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. 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, 1996); (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. 11
STATEMENTS OF OPERATIONS Years ended December 31, 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------- Net sales ...................................................................... $ 85,866,525 $ 48,631,855 $ 2,798,174 Cost of goods sold ............................................................. 33,346,878 17,554,413 1,789,545 -------------------------------------------- Gross profit .............................................................. 52,519,647 31,077,442 1,008,629 -------------------------------------------- Operating expenses: Marketing and selling ..................................................... 26,798,820 16,695,428 3,099,806 General and administrative ................................................ 2,869,163 1,926,988 666,459 Product development ....................................................... 1,109,062 56,940 0 -------------------------------------------- Total operating expenses .............................................. 30,777,045 18,679,356 3,766,265 -------------------------------------------- Operating income (loss) ............................................... 21,742,602 12,398,086 (2,757,636) Other income (expense): Interest income ........................................................... 2,279,882 583,919 207,480 Interest expense .......................................................... 0 (12,500) (7,945) -------------------------------------------- Other income, net ..................................................... 2,279,882 571,419 199,535 -------------------------------------------- Income (loss) from continuing operations before income taxes .......... 24,022,484 12,969,505 (2,558,101) Income tax benefit (expense) ................................................... (8,500,000) 341,000 0 -------------------------------------------- Income (loss) from continuing operations .................................. 15,522,484 13,310,505 (2,558,101) Loss from operations of discontinued sleep division (less applicable income tax benefit of $259,000 in 1995) .......................................... 0 (459,901) (309,314) Gain on sale of sleep division (less applicable income taxes of $690,00 in 1995) 0 1,225,890 0 -------------------------------------------- Net income (loss) ..................................................... $ 15,522,484 $ 14,076,494 $ (2,867,415) ============================================ Net income (loss) per common and common equivalent share: From continuing operations ................................................ $ .78 $ .72 $ (.16) From discontinued operations .............................................. .00 .04 (.02) -------------------------------------------- Net income (loss) per share ........................................... $ .78 $ .76 $ (.18) ============================================ Weighted average number of common and common equivalent shares outstanding ...................................... 19,807,000 18,376,000 15,755,000 ============================================
The accompanying notes are an integral part of the financial statements. 12
BALANCE SHEETS December 31, 1996 1995 - -------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents ......................................................... $12,109,150 $ 2,593,113 Marketable securities ............................................................. 50,339,193 7,909,160 Accounts receivable, net of allowance for doubtful accounts of $210,000 in 1996 and $201,000 in 1995 ...................................... 14,665,731 7,830,793 Inventories ....................................................................... 8,314,826 11,100,909 Prepaid expenses and other current assets ......................................... 1,647,055 997,674 Deferred income taxes ............................................................. 961,000 879,000 ------------------------- Total current assets .............................................................. 88,036,955 31,310,649 Property and equipment, net ............................................................ 839,415 558,999 Patents and trademarks, net ............................................................ 192,633 126,887 Certificate of deposit, restricted ..................................................... 340,064 320,000 Deferred income taxes .................................................................. 0 24,000 ------------------------- $89,409,067 $32,340,535 ========================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable .................................................................. $ 5,134,683 $ 3,778,077 Accrued expenses .................................................................. 3,179,944 1,169,116 Accrued income taxes .............................................................. 1,319,533 508,000 ------------------------- Total current liabilities ......................................................... 9,634,160 5,455,193 ------------------------- 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 19,145,445 shares in 1996 and 17,387,852 shares in 1995 ....................... 191,454 173,878 Additional paid-in capital ........................................................ 63,177,939 25,828,434 Retained earnings ................................................................. 16,405,514 883,030 ------------------------- Total stockholders' equity ........................................................ 79,774,907 26,885,342 ------------------------- Commitments (notes 9 and 10) ------------------------- $89,409,067 $32,340,535 =========================
The accompanying notes are an integral part of the financial statements. 13
STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994 Common stock ------------------- Additional Retained Total Number Par paid-in earnings stockholders' of shares value capital (deficit) equity - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1993 13,203,104 $ 132,032 $ 14,065,523 $(10,326,049) $ 3,871,506 Proceeds from public stock offering less issuance costs of $1,119,000 3,450,000 34,500 9,627,382 0 9,661,882 Stock issued in connection with Employee Stock Purchase Plan 15,552 154 33,676 0 33,830 Stock options exercised 133,000 1,330 163,352 0 164,682 Warrants exercised 240,000 2,400 339,600 0 342,000 Warrants issued 0 0 50 0 50 Net loss for the year 0 0 0 (2,867,415) (2,867,415) ------------------------------------------------------------------------ Balance at December 31, 1994 17,041,656 170,416 24,229,583 (13,193,464) 11,206,535 Stock issued in connection with Employee Stock Purchase Plan 5,365 54 22,377 0 22,431 Stock options exercised 129,870 1,299 379,034 0 380,333 Tax benefit from stock options exercised 0 0 485,000 0 485,000 Warrants exercised, less issuance costs of $35,000 210,961 2,109 712,440 0 714,549 Net income for the year 0 0 0 14,076,494 14,076,494 ------------------------------------------------------------------------ Balance at December 31, 1995 17,387,852 173,878 25,828,434 883,030 26,885,342 Proceeds from public stock offering less issuance costs of $2,469,000 1,525,000 15,250 35,449,926 0 35,465,176 Stock issued in connection with Employee Stock Purchase Plan 893 9 11,048 0 11,057 Stock options exercised 231,700 2,317 683,531 0 685,848 Tax benefit from stock options exercised 0 0 1,205,000 0 1,205,000 Net income for the year 0 0 0 15,522,484 15,522,484 ------------------------------------------------------------------------ Balance at December 31, 1996 19,145,445 $ 191,454 $ 63,177,939 $ 16,405,514 $ 79,774,907 ========================================================================
The accompanying notes are an integral part of the financial statements. 14
STATEMENTS OF CASH FLOWS Years ended December 31, 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- Operating activities: Net income (loss) ................................................ $ 15,522,484 $ 14,076,494 $ (2,867,415) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Net gain on sale of assets of discontinued operations .......... 0 (1,915,890) 0 Depreciation and amortization .................................. 259,822 187,428 59,707 Deferred income taxes .......................................... (58,000) (418,000) 0 Changes in operating assets and liabilities: Accounts receivable .......................................... (6,834,938) (6,894,514) (744,552) Inventories .................................................. 2,786,083 (9,975,900) (717,626) Prepaid expenses and other current assets .................... (649,381) (752,055) (195,484) Net assets of discontinued operations ........................ 0 (814,201) 205,433 Accounts payable and accrued expenses ........................ 5,383,967 5,048,857 54,955 ------------------------------------------------ Net cash provided by (used in) operating activities ..... 16,410,037 (1,457,781) (4,204,982) ------------------------------------------------ Investing activities: Purchases of marketable securities ............................... (177,630,971) (42,709,438) (14,118,156) Sales and maturities of marketable securities .................... 135,200,938 39,768,835 9,149,599 Payments for purchases of property and equipment ................. (464,675) (383,810) (229,414) Payments for patents and trademarks .............................. (141,309) (73,426) (90,906) Purchase of certificate of deposit, restricted ................... (20,064) (320,000) 0 Net proceeds from promissory note ................................ 0 595,611 0 ------------------------------------------------ Net cash used in investing activities ................... (43,056,081) (3,122,228) (5,288,877) ------------------------------------------------ Financing activities: Net proceeds from sale of discontinued operations ................ 0 5,000,000 0 Net proceeds from public stock offering .......................... 35,465,176 0 9,661,932 Proceeds from the issuance of common stock under Employee Stock Purchase Plan ........................... 11,057 22,431 33,830 Proceeds from the exercise of stock options ...................... 685,848 380,333 164,682 Proceeds from exercise of common stock warrants .................. 0 714,549 342,000 ------------------------------------------------ Net cash provided by financing activities ............... 36,162,081 6,117,313 10,202,444 ------------------------------------------------ Net increase in cash and cash equivalents ............... 9,516,037 1,537,304 708,585 Cash and cash equivalents: Beginning of year ................................................ 2,593,113 1,055,809 347,224 ------------------------------------------------ End of year ...................................................... $ 12,109,150 $ 2,593,113 $ 1,055,809 ------------------------------------------------ Supplemental disclosure of cash flow information: Cash paid during the year for interest ........................... $ 0 $ 12,500 $ 12,945 Cash paid during the year for income taxes ....................... 6,541,467 0 0 ================================================
The accompanying notes are an integral part of the financial statements. 15 NOTES TO FINANCIAL STATEMENTS December 31, 1996, 1995 and 1994 NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS CNS, Inc. ("the Company"), designs, manufactures and markets consumer products, primarily the Breathe Right nasal strip. The Breathe Right nasal strip is a nonprescription, single use, disposable device that can reduce or eliminate snoring by improving nasal breathing and temporarily 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 estimated 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. PATENTS AND TRADEMARKS Patents and trademarks are stated at cost and are amortized over three years using the straight-line method. STOCK BASED COMPENSATION The Company applies Accounting Principles Board Opinion No. 25 (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. The Company has adopted the disclosure requirements under Statement of Financial Accounting Standards No. 123 (SFAS No. 123), Accounting and Disclosure of Stock-Based Compensation. 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 (LOSS) PER SHARE Net income per share has been computed based upon the weighted average number of common and common equivalent shares outstanding during the year. Net loss per common share has been computed using the weighted average number of common shares outstanding during the year. RECLASSIFICATION Certain prior year amounts have been reclassified to conform to the 1996 presentation. 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 operations as the loss from discontinued operations. NOTE 3 MARKETABLE SECURITIES Marketable securities, including estimated fair value based on quoted market prices or valuation models, at December 31, 1996 and 1995 are summarized as follows (in thousands): December 31, 1996 1995 - ----------------------------------------------------------------------------- Cost Fair Value Cost Fair Value - ----------------------------------------------------------------------------- Commercial paper $ 2,983 $ 2,983 $ 0 $ 0 Corporate bonds 6,045 6,045 0 0 U.S. Government obligations 1,998 1,998 7,909 7,909 Municipal bonds 39,313 39,313 0 0 - ----------------------------------------------------------------------------- Total marketable securities $50,339 $50,339 $ 7,909 $ 7,909 ============================================================================= Maturities of marketable securities at December 31, 1996 are as follows (in thousands): Cost Fair Value - ----------------------------------------------------------------------------- Due within one year $22,997 $22,997 Due after one year through three years 27,342 27,342 - ----------------------------------------------------------------------------- Total marketable securities $50,339 $50,339 ============================================================================= There were no realized gains or losses during 1996, 1995 or 1994. NOTE 4 ADVERTISING At December 31, 1996 and 1995 $212,000 and $561,000, respectively, of advertising costs were reported as assets. Advertising expense was $16,215,000 in 1996, $11,839,000 in 1995, and $2,429,000 in 1994. 16 NOTE 5 DETAILS OF SELECTED BALANCE SHEET ACCOUNTS Details of selected balance sheet accounts are as follows (in thousands): 1996 1995 1994 - --------------------------------------------------------------------- Allowance for doubtful accounts: Balance beginning of year $201 $ 55 $ 0 Plus provision for doubtful accounts 123 154 55 Less charge offs 114 8 0 - --------------------------------------------------------------------- Balance end of year $210 $201 $ 55 ===================================================================== December 31, 1996 1995 - --------------------------------------------------------------------- Inventories: Finished goods $ 6,254 $ 9,364 Work in process 462 200 Raw materials and component parts 1,599 1,537 - --------------------------------------------------------------------- Total inventories $ 8,315 $11,101 ===================================================================== Property and equipment: Production equipment $ 789 $ 527 Office equipment and leasehold improvements 376 173 - --------------------------------------------------------------------- 1,165 700 Less accumulated depreciation and amortization 326 141 - --------------------------------------------------------------------- Property and equipment, net $ 839 $ 559 ===================================================================== Patents and trademarks: Patents and trademarks $ 366 $ 224 Less accumulated amortization 173 97 - --------------------------------------------------------------------- Patents and trademarks, net $ 193 $ 127 ===================================================================== Accrued expenses: Promotions and allowances $ 1,305 $ 386 Royalties and commissions 1,284 643 Salaries, incentives and paid time off 392 102 Other 199 38 - --------------------------------------------------------------------- Total accrued expenses $ 3,180 $ 1,169 ===================================================================== NOTE 6 STOCKHOLDERS' EQUITY STOCK OPTIONS The Company's stock option plans allow for grant of options to officers, directors, and employees to purchase up to 2,200,000 shares of common stock at exercise prices not less than 100% of fair market value on the dates of grant. The term of the options may not exceed ten years 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, 1996. 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, 1993 $ 1.64 682,000 331,222 1994 plan -- 0 1,000,000 Granted 3.28 530,000 (530,000) Exercised 1.24 (133,000) 0 Canceled 2.25 (31,400) 31,400 - ----------------------------------------------------------------------- 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 ======================================================================= At December 31, 1996, the range of exercise prices and weighted-average remaining contractual life of outstanding options was $1.31 - $21.13 and 7.5 years, respectively. At December 31, 1996 and 1995, currently exercisable options aggregated 775,700 shares and 653,000 shares of common stock, respectively and the weighted-average exercise price of those options was $3.87 and $3.10, respectively. The per share weighted-average fair value of stock options granted during 1996 and 1995 is estimated as $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 5.4% 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 and Disclosure of Stock-Based Compensation, the Company's net income and earnings per share would have been reduced by approximately $900,000, or $.04 per share in 1996 and $1.5 million, or $.08 per share in 1995. Pro forma net income reflects only options granted in 1996 and 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the 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 17 the plan of which 136,386 shares have been purchased by employees as of December 31, 1996. WARRANTS In connection with an agreement to license a product to be marketed as the Breathe Right device, the licenser was issued a warrant to purchase 100,000 shares of the Company's common stock exercisable at a price of $2.75 per share which expires March 1997. During 1995 a total of 12,500 shares were exercised. During 1995 warrants to purchase 200,000 shares at $3.75 were exercised. The warrants had been issued in 1994 to the underwriter of the Company's 1994 public stock offering. During 1994 warrants to purchase 240,000 shares at $1.425 were exercised. The warrants had been issued in 1992 to the underwriter of the Company's 1992 public stock offering. PREFERRED STOCK At December 31, 1996, the Company is authorized to issue 1,000,000 shares of Series A Junior Participating Preferred Stock upon a triggering event under the Company's stockholders' rights plan and 7,483,589 shares of undesignated preferred stock. NOTE 7 INCOME TAXES Income tax expense (benefit), from continuing operations, for the three years ended December 31, 1996, excluding tax on discontinued operations, is as follows (in thousands): Current Deferred Total - -------------------------------------------------------------------------- 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) =================================== There was no tax expense in 1994. 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): 1996 1995 1994 - ------------------------------------------------------------------------------ Computed tax expense (benefit) $ 8,408 $ 4,539 $ (895) State taxes, net of federal benefit 452 389 0 Benefit of foreign sales corporation (417) 0 0 Change in deferred tax asset valuation allowance 0 (5,439) 895 Other 57 170 0 ------------------------------------ Actual tax expense (benefit) $ 8,500 $ (341) $ 0 ==================================== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities for 1996 and 1995 are presented below (in thousands): December 31, 1996 1995 - ------------------------------------------------------------ Deferred tax assets: Inventory items $ 294 $ 275 Accounts receivable allowance 78 74 Patents and trademarks 55 31 Accrued expenses 574 213 Tax credits 24 316 ---------------------- 1,025 909 Deferred tax liabilities: Property and equipment (64) (6) ---------------------- Net deferred tax assets $ 961 $ 903 ====================== NOTE 8 SALES The Company had two significant customers, including 3M Company, who accounted for approximately 42% of total sales in 1996, one significant customer who accounted for approximately 13% of total sales in 1995, and two significant customers who accounted for approximately 37% of total sales in 1994. Accounts receivable from these customers as of December 31, 1996 and 1995 were $6,762,000 and $1,319,000, respectively. Foreign sales by geographic area are as follows (in thousands): 1996 1995 1994 - ------------------------------------------------------------ Europe $12,617 $ 162 $ 0 Asia 10,616 370 0 Other 2,535 904 0 ------------------------------ Total foreign sales $25,768 $1,436 $ 0 ============================== 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 $300,000 in 1997 and $450,000 each year thereafter until the patent for the product expires. Royalty expense was $2,647,000 in 1996, $1,458,000 in 1995, and $111,000 in 1994. NOTE 10 OPERATING LEASES The Company leases equipment and office space under non-cancelable operating leases which expire over the next four years. Future minimum lease payments due in accordance with these leases as of December 31, 1996 are as follows (in thousands): Year ending December 31, Amount - ------------------------------------------------------------- 1997 $ 446 1998 446 1999 446 2000 409 ------- Future minimum lease payments $1,747 ======= Total rental expense for operating leases was $473,000 in 1996, $377,000 in 1995, and $351,000 in 1994. 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 $340,000 certificate of deposit which bears interest at 5.75% per annum and matures on April 30, 1998. 18 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, 1996 and 1995 and the related statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996. 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, 1996 and 1995 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. Minneapolis, Minnesota January 28, 1997 COMMON STOCK INFORMATION PRICE RANGE The Common Stock of the Company has been traded under the symbol "CNXS"on the NASDAQ National Market since April 8, 1994. The following table sets forth the high and low last sale prices of the Company's stock for the periods indicated. The prices prior to June 23, 1995 have been adjusted to reflect the Company's two-for-one stock split of that date. 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 1995 High Low - ------------------------------------------------------------------- First Quarter $ 9 5/8 $ 4 7/16 Second Quarter 19 9 15/16 Third Quarter 24 1/4 13 1/8 Fourth Quarter 17 3/8 9 1/2 SHAREHOLDERS As of March 3, 1997, there were approximately 1,000 owners of record of the Common Stock and an estimated 22,000 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. 19 EX-21.1 8 SUBSIDIARIES OF THE COMPANY EXHIBIT 21.1 SUBSIDIARIES OF THE COMPANY Jurisdiction Name of Subsidiary of Organization - ------------------ --------------- CNS FSC, Inc. Barbados EX-23.1 9 CONSENT OF INDEPENDENT AUDITOR INDEPENDENT AUDITORS' CONSENT The Board of Directors CNS, Inc,: We consent to incorporation by reference in the Registration Statements Nos. 33-19044, 33-29454, 33-42971, and 33-59719 on Form S-8 of CNS, Inc. of our report dated January 28, 1997, relating to the balance sheets of CNS, Inc. as of December 31, 1996 and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1996, which report appears in the December 31, 1996 annual report on Form 10-K of CNS, Inc. KPMG Peat Marwick LLP Minneapolis, Minnesota March 21, 1997 EX-27 10 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 12,109,150 50,339,193 14,665,731 0 8,314,826 88,036,955 839,415 0 89,409,067 9,634,160 0 0 0 191,454 79,583,453 89,409,067 85,866,525 85,866,525 33,346,878 30,777,045 0 0 0 24,022,484 8,500,000 15,522,484 0 0 0 15,522,484 .78 .78
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