UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the Period Ended September 30, 1998.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the Transition Period from to
COMMISSION FILE NUMBER: 0 - 16612
CNS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 41-1580270
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. BOX 39802
MINNEAPOLIS, MN 55439
(Address of principal executive offices including zip code)
(612) 820-6696
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
At October 30, 1998, 17,522,014 shares of common stock were outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
CNS, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,806,769 $ 229,647
Marketable securities 61,723,505 59,458,236
Accounts receivable, net 8,070,742 11,392,001
Inventories 6,436,237 8,624,663
Prepaid expenses and other current assets 2,755,734 3,295,001
Deferred income taxes 1,736,000 1,770,000
------------ ------------
Total current assets 84,528,987 84,769,548
Property and equipment, net 2,456,899 1,863,007
Product rights, net 1,419,400 1,502,520
Certificate of deposit, restricted 0 359,898
------------ ------------
$ 88,405,286 $ 88,494,973
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses 8,826,962 6,691,939
Accrued income taxes 154,937 1,158,533
------------ ------------
Total current liabilities 8,981,899 7,850,472
------------ ------------
Stockholders' equity:
Preferred stock - authorized 8,483,589 shares;
none issued or outstanding 0 0
Common stock - $.01 par value; authorized 50,000,000 shares;
issued and outstanding, 19,294,570 shares 192,946 192,946
Additional paid-in capital 63,495,718 63,495,718
Treasury shares - at cost; 1,528,456 at September 30, 1998 and
961,511 at December 31, 1997 (11,009,542) (8,219,993)
Retained earnings 26,744,265 25,175,830
------------ ------------
Total stockholders' equity 79,423,387 80,644,501
------------ ------------
$ 88,405,286 $ 88,494,973
============ ============
</TABLE>
The accompanying notes are an integral part
of the condensed financial statements.
2
<PAGE>
CNS, INC.
CONDENSED STATEMENTS OF INCOME
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net sales $ 12,749,081 $ 12,642,798 $ 39,187,364 $ 45,631,043
Cost of goods sold 4,241,459 3,896,836 13,164,543 14,598,201
------------ ------------ ------------ ------------
Gross profit 8,507,622 8,745,962 26,022,821 31,032,842
------------ ------------ ------------ ------------
Operating expenses:
Marketing and selling 7,032,080 4,581,778 22,306,603 20,605,798
General and administrative 810,191 933,104 3,024,687 2,507,220
Product development 539,878 246,229 1,524,275 737,018
------------ ------------ ------------ ------------
Total operating expenses 8,382,149 5,761,111 26,855,565 23,850,036
------------ ------------ ------------ ------------
Operating income (loss) 125,473 2,984,851 (832,744) 7,182,806
Interest income 711,788 773,621 2,131,179 2,260,632
------------ ------------ ------------ ------------
Income before income taxes 837,261 3,758,472 1,298,435 9,443,438
Income tax (provision) benefit (100,000) (1,200,000) 270,000 (2,950,000)
------------ ------------ ------------ ------------
Net income $ 737,261 $ 2,558,472 $ 1,568,435 $ 6,493,438
============ ============ ============ ============
Basic net income per share $ .04 $ .13 $ .09 $ .34
============ ============ ============ ============
Diluted net income per share $ .04 $ .13 $ .08 $ .33
============ ============ ============ ============
Weighted average number of common
shares outstanding 18,202,000 19,274,000 18,346,000 19,244,000
============ ============ ============ ============
Weighted average number of common and
assumed conversion shares outstanding 18,323,000 19,907,000 18,528,000 19,976,000
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part
of the condensed financial statements.
3
<PAGE>
CNS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Operating activities:
Net income $ 1,568,435 $ 6,493,438
Adjustments to reconcile net income to net cash
from operating activities:
Depreciation and amortization 610,069 335,241
Deferred income taxes 34,000 (41,000)
Changes in operating assets and liabilities:
Accounts receivable 3,321,261 6,788,052
Inventories 2,188,426 (1,170,687)
Prepaid expenses and other current assets 539,270 (1,628,308)
Accounts payable and accrued expenses 1,131,420 (1,752,220)
------------ ------------
Net cash from operating activities 9,392,881 9,024,516
------------ ------------
Investing activities:
Change in marketable securities (2,265,268) (11,767,666)
Payments for purchases of property and equipment (981,656) (1,010,325)
Payments for product rights (139,185) (1,273,378)
Change in certificate of deposit, restricted 359,898 (9,750)
------------ ------------
Net cash from investing activities (3,026,211) (14,061,119)
------------ ------------
Financing activities:
Proceeds from issuance of common stock
under Employee Stock Purchase Plan 6,946 7,190
Proceeds from the exercise of stock options 228,063 312,081
Purchase of treasury shares (3,024,557) (907,888)
------------ ------------
Net cash from financing activities (2,789,548) (588,617)
------------ ------------
Net change in cash and cash equivalents 3,577,122 (5,625,220)
Cash and cash equivalents:
Beginning of period 229,647 12,109,150
------------ ------------
End of period $ 3,806,769 $ 6,483,930
============ ============
</TABLE>
The accompanying notes are an integral part of the
condensed financial statements.
4
<PAGE>
NOTES TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements as of September 30, 1998 and
1997 are unaudited but, in the opinion of management, include all adjustments
(consisting only of normal, recurring accruals) necessary for a fair
presentation of results for the interim periods presented.
Note 1 - Accounting Principles
The accounting principles followed in the preparation of the financial
information contained herein are the same as those described in the Form 10-K
report for the year ended December 31, 1997, and reference is hereby made to
that report for detailed information on accounting policies.
Note 2 - Earnings Per Share
A reconciliation of basic and diluted average common shares outstanding is as
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -----------------------
1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Average common shares outstanding 18,202,000 19,274,000 18,346,000 19,244,000
Assumed conversion of stock options 121,000 633,000 182,000 732,000
- -----------------------------------------------------------------------------------------------
Average common and assumed
conversion shares 18,323,000 19,907,000 18,528,000 19,976,000
- -----------------------------------------------------------------------------------------------
</TABLE>
5
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company's revenues are derived primarily from the manufacture and sale of
the Breathe Right(R) nasal strip, which is a nonprescription disposable device
that can reduce or eliminate snoring by improving nasal breathing and
temporarily relieve nasal congestion and breathing difficulties due to a
deviated nasal septum. During the first quarter of 1998 the Company began the
rollout of Banish(TM) personal smoke deodorizer, which removes smoke odor from
clothing and hair. During the third quarter of 1998 the Company began the
rollout of Breathe Right Allergen Barrier Pillow Covers and Saline Nasal Spray.
The Company also has entered into several agreements to market or license
certain other new consumer products that are in various stages of evaluation and
testing.
Results of Operations
Net sales were $12.7 million for the third quarter of 1998 compared to $12.6
million for the same quarter of 1997 and were $39.2 million for the first nine
months of 1998 compared to $45.6 million for the same period of 1997.
Domestic sales increased to $12.6 million from $12.4 million in the third
quarter of 1997 as retail sell-through of Breathe Right nasal strips held
steady. Domestic sales for the first nine months of 1998 were $37.7 million
compared to $41.9 million for the same period of 1997. This decline was
primarily a result of the failure of marketing efforts in the first quarter of
1998 to generate sufficient growth of Breathe Right nasal strip purchasers.
International sales were only $168,000 for the third quarter of 1998 compared to
$290,000 for the same quarter of 1997 and were $1.5 million for the first nine
months of 1998 compared to $3.7 million for the same period of 1997. The lower
level of international sales for 1998 reflects continued high inventory levels
at 3M, the Company's international distributor.
Gross profit was $8.5 million or 66.7% of net sales for the third quarter of
1998 compared to $8.7 million or 69.2% for the same quarter of 1997 and was
$26.0 million or 66.4% for the first nine months of 1998 compared to $31.0
million or 68.0% for the same period of 1997. The lower gross profit percentage
was primarily due to the sale of Breathe Right nasal strips for a sampling
program, where the nasal strips are distributed to new home buyers, and the
introduction of new products with lower gross profit margins.
Marketing and selling expenses were $7.0 million for the third quarter of 1998
compared to $4.6 million for the same quarter of 1997 and were $22.3 million for
the first nine months of 1998 compared to $20.6 million for the same period in
1997. The increase for the third quarter resulted primarily from expenses
associated with the rollout and market testing of Banish personal smoke
deodorizer.
General and administrative expenses were $810,000 for the third quarter of 1998
compared to $933,000 for the same quarter of 1997 and were $3.0 million for the
first nine months of 1998
6
<PAGE>
compared to $2.5 million for the same period in 1997. This increase for the nine
months was primarily due to expenses associated with patent litigation that was
settled in the second quarter of 1998 and personnel costs.
Product development expenses were $540,000 for the third quarter of 1998
compared to $246,000 for the same quarter of 1997 and were $1.5 million for the
first nine months of 1998 comparable to $737,000 for the same period in 1997.
This increase resulted from costs related to evaluation and testing of potential
new products.
Interest income was $712,000 for the third quarter of 1998 compared to $774,000
for the same quarter of 1997 and was $2.1 million for the first nine months of
1998 comparable to $2.3 million for the same period in 1997. The decrease was
primarily due to a lower level of funds available for investment following stock
repurchases in the fourth quarter of 1997 and third quarter of 1998.
Income tax (expense) benefit for the third quarter of 1998 was an expense of
$100,000 compared to $1.2 million for the same quarter of 1997 and was a benefit
of $270,000 for the first nine months of 1998 compared to an expense of $3.0
million for the same period of the prior year. The effective income tax rate is
impacted by a high level of tax exempt interest income.
Net income for the third quarter of 1998 was $737,000 or $.04 per share compared
to $2.6 million or $.13 per share for the same quarter of 1997 and was $1.6
million or $.08 per share for the first nine months of 1998 compared to $6.5
million or $.33 per share for the same period of 1997. This decrease was due
primarily to lower sales and higher operating expenses as noted above.
Seasonality
The Company believes that a significant portion of Breathe Right nasal strip
users currently use the product for the temporary relief of nasal congestion and
congestion-related snoring. Sales of nasal congestion remedies are higher during
the fall and winter seasons because of increased use during the cold season. For
this reason the Company's domestic net sales have been relatively higher in the
first and fourth quarters.
Liquidity and Capital Resources
At September 30, 1998, the Company had cash and cash equivalents and marketable
securities of $65.5 million and working capital of $75.5 million.
The Company generated cash from operations of $9.4 million for the first nine
months of 1998 compared with $9.0 million for the same period of 1997. The
increased cash flow was due primarily to a decrease in net operating assets and
liabilities offset by a decrease in net income.
7
<PAGE>
The Company invested $2.3 million in marketable securities, $982,000 in property
and equipment and $139,000 in product rights while a $360,000 certificate of
deposit, restricted matured during the first nine months of 1998.
The Company received $235,000 during the first nine months of 1998 from employee
stock plan transactions. In October 1998 the Company completed the repurchase of
750,000 shares of its common stock authorized by the Board of Directors in April
1998. In October 1998 the Board authorized the Company to purchase from
time-to-time up to an additional 1,500,000 shares of its common stock, to be
used to meet the Company's obligations under its employee stock ownership plan
and stock option plans, and for possible future acquisitions.
The Company believes that its existing funds and funds generated from operations
will be sufficient to support its planned operations for the foreseeable future.
Year 2000
The Company is evaluating the potential impact of what is commonly referred to
as the Year 2000 issue, concerning the inability of certain information systems
to properly recognize and process dates containing the year 2000 and beyond. The
Company has established a Year 2000 team, and this team has worked with
management to commence the following steps: (i) implementing a Year 2000
assessment and testing plan for all internal information systems and other
systems that contain microcontrollers that may be affected by the Year 2000 date
change; (ii) communicating with third parties that supply product to the Company
to ensure they are addressing the Year 2000 issue; and (iii) contingency and
disaster recovery planning to ensure Year 2000 problem resolution.
The Company has identified and tested the systems it believes are critical, and
the test results indicate that these systems are Year 2000 compliant. The
Company expects to complete testing and establish compliance with respect to all
of its systems and products by March 31, 1999, subject to possible equipment
upgrades during 1999 and ongoing communications with third parties. Regardless
of the Year 2000 compliance of the Company's systems and products, there can be
no assurance that the Company will not be adversely affected by the failure of
others to become Year 2000 compliant.
The Company estimates that its direct costs for Year 2000 compliance will
consist primarily of costs related to the staff time devoted to Year 2000
compliance. The Company does not expect capital expenditures will be necessary
related to Year 2000 compliance. Costs and capital expenditures in these areas
have not been material for historical periods.
As noted below under "Forward-Looking Statements," statements in this section
that are not historical or current facts are forward-looking statements made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995, including statements regarding the timetable for Year 2000
compliance, the Company's costs and capital expenditures, the success of the
Company's efforts and others' efforts to achieve compliance, and the effects of
the Year 2000 issue on the Company's future financial condition and results of
operations. These
8
<PAGE>
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical results and those presently
anticipated or projected. The following important factors, among others, could
affect the accuracy of these statements: (i) the inherent uncertainty of the
costs and timing of achieving compliance on the wide variety of systems used by
the Company; (ii) the reliance on the efforts of vendors, customers, government
agencies and other third parties to achieve adequate compliance and avoid
disruption of the Company's business in early 2000; and (iii) the uncertainty of
the ultimate costs and consequences of any unanticipated disruption in the
Company's business resulting from the failure of one of the Company's
applications or of a third party's systems. The foregoing list is not
exhaustive, and the Company disclaims any obligation subsequently to revise any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.
Forward Looking Statements
This Form 10-Q 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, which have been, and in the future may be, subject to
litigation; (iii) the markets in which the Company competes are highly
competitive; (iv) the Year 2000 factors noted above; and (v) the additional
factors listed in the statement "Forward Looking Statements" included in the
Company's Annual Report on Form 10-K.
9
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
The deadline for the submission of shareholder proposals
pursuant to Rule 14a-8 under the Securities Exchange Act of
1934, as amended, for inclusion in the Company's proxy
statement for its 1999 Annual Meeting of Shareholders is
November 19, 1998. Additionally, if the Company receives
notice of a shareholder proposal after February 1, 1999, such
proposal will be considered untimely pursuant to Rules 14a-4
and 14a-5(e) and the persons named in proxies solicited by the
Board of Directors of the Company may exercise discretionary
voting power with respect to such proposal.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit No. 27, Financial Data Schedule
(b) Reports on Form 8-K
None
10
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CNS, Inc.
--------------------------------------------------
Registrant
Date: November 6, 1998 By: /s/ Marti Morfitt
----------------- ---------------------------------------------
Marti Morfitt
President & Chief Operating Officer
Date: November 6, 1998 By: /s/ David J. Byrd
----------------- ---------------------------------------------
David J. Byrd
Vice President of Finance and Chief
Financial Officer
11
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,806,769
<SECURITIES> 61,723,505
<RECEIVABLES> 8,070,742
<ALLOWANCES> 0
<INVENTORY> 6,436,237
<CURRENT-ASSETS> 84,528,987
<PP&E> 2,456,899
<DEPRECIATION> 0
<TOTAL-ASSETS> 88,405,286
<CURRENT-LIABILITIES> 8,981,899
<BONDS> 0
0
0
<COMMON> 192,946
<OTHER-SE> 79,230,441
<TOTAL-LIABILITY-AND-EQUITY> 88,405,286
<SALES> 39,187,364
<TOTAL-REVENUES> 39,187,364
<CGS> 13,164,543
<TOTAL-COSTS> 26,855,565
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,298,435
<INCOME-TAX> (270,000)
<INCOME-CONTINUING> 1,568,435
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,568,435
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.08
</TABLE>
