CNS INC /DE/, 10-K, 1998-03-31

CNS INC /DE/
10-K, 1998-03-31
ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 1997

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Transition period from _________ to __________

COMMISSION FILE NUMBER: 0-16612

CNS, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 41-1580270
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)

P.O. BOX 39802
MINNEAPOLIS, MN 55439
(Address of principal executive offices and zip code)

Registrant's telephone number, including area code: (612) 820-6696

Securities registered pursuant to section 12(b) of the Act: None

Securities registered pursuant to section 12(g) of the Act:

Title of each class
Common stock, par value of $.01 per share
Preferred stock purchase rights

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES _X_ No___

Indicate by check mark if disclosure of delinquent filers pursuant to Rule 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of March 3, 1998, assuming as market value the price of $6.3125 per share,
the closing sale price of the Company's Common Stock on the Nasdaq National
Market, the aggregate market value of shares held by non-affiliates was
approximately $103,643,000.

As of March 3, 1998, the Company had outstanding 18,393,059 shares of Common
Stock of $.01 par value per share.

Documents Incorporated by Reference: The Company's (i) Annual Report to
Stockholders for the year ended December 31, 1997, and (ii) Proxy Statement for
its Annual Meeting of Stockholders to be held on April 22, 1998, are
incorporated by reference into Parts II and III of this Form 10-K.

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TABLE OF CONTENTS

PAGE
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PART I

<S> <C> <C>
Item 1. Business................................................................................. 3
Item 2. Properties............................................................................... 14
Item 3. Legal Proceedings........................................................................ 15
Item 4. Submission of Matters to a Vote of Security Holders...................................... 15

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 16
Item 6. Selected Financial Data.................................................................. 16
Item 7. Management's Discussion and Analysis of Financial Condition.............................. 16
and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures about Market Risk............................... 16
Item 8. Financial Statements and Supplementary Data.............................................. 16
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................................. 16

PART III

Item 10. Directors and Executive Officers of the Registrant....................................... 17
Item 11. Executive Compensation................................................................... 17
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 17
Item 13. Certain Relationships and Related Transactions........................................... 17

PART IV

Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K................................................................... 18

SIGNATURES ......................................................................................... 19

</TABLE>

<PAGE>

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements
under the Private Securities Litigation Reform Act of 1995 that are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those presently anticipated or projected. Such forward-looking
statements can be identified by the use of terminology such as "may," "will,"
"expect," "plan," "intend," "anticipate," "estimate," or "continue" or
comparable terminology. Factors that could cause actual results to differ from
the results discussed in the forward-looking statements include, but are not
limited to the following factors: (i) the Company's revenue and profitability is
currently reliant on sales of a single product, Breath Right nasal strips; (ii)
the Company's success will depend, to a large extent, on the enforceability and
comprehensiveness of the patents on the Breathe Right(R) nasal strip technology,
which have been, and in the future may be, the subject of litigation (see Item
3, Legal Proceedings); (iii) the markets in which the Company competes are
highly competitive; (iv) the Company will face challenges in successfully
introducing any new products; (v) the fact that the Company is dependant upon
contract manufacturers for the production of substantially all of its products;
(vi) the fact that the Company is partially dependent upon 3M Company for sale
of its products internationally, and (vii) the fact that the Company's products
are generally subject to government regulation.

PART I

ITEM 1. BUSINESS

GENERAL

CNS, Inc. (the "Company") develops and markets consumer products,
including the Breathe Right nasal strip. The Breathe Right strip improves
breathing by reducing nasal airflow resistance. It can be effective in
eliminating or reducing snoring, for the temporary relief of nasal congestion
and for the temporary relief of breathing difficulties due to a deviated nasal
septum. The Company recently launched BANISH (TM), a personal smoke deodorizer
that removes same-day tobacco smoke odor trapped in clothing and hair. The
Company also has entered into or is exploring a number of agreements to market
or license other new consumer products, including a chewable dietary fiber
tablet. These new products are in various stages of evaluation and testing.

PRODUCTS

BREATHE RIGHT NASAL STRIPS. The Breathe Right nasal strip is a
nonprescription single-use disposable device that improves breathing by reducing
nasal airflow resistance. The Company received 510(k) clearances from the United
States Food and Drug Administration ("FDA") to market the Breathe Right nasal
strip for improvement of nasal breathing (October 1993), reduction or
elimination of snoring (November 1995), temporary relief of nasal congestion
(February 1996) and temporary relief of breathing difficulties due to a deviated
nasal septum (May 1996). The Breathe Right nasal strip comes both in tan and a
nearly transparent product, the Breathe Right Near Clear(TM) nasal strip.

The Breathe Right nasal strip includes two embedded plastic strips.
When folded down onto the sides of the nose, the Breathe Right nasal strip lifts
the side walls of the nose outward to open the nasal passages. The product
improves nasal breathing upon application and does not include any medication,
thereby avoiding any medicinal side effects. The Breathe Right nasal strip is
offered in three sizes

<PAGE>

(junior/small, small/medium and medium/large) to accommodate the range of nose
sizes from a child's nose to an adult's nose. The Breathe Right nasal strip is
packaged for the consumer market in quantities of 10, 24 or 30 strips per box.
The Company believes that the Breathe Right nasal strip is priced comparably to
medicinal decongestants on a daily or nightly dosage basis at suggested retail
prices of $4.99 for a box of ten and $11.99 for a box of 30. The Company
introduced its new Breathe Right Near Clear nasal strips at a suggested retail
price of $11.99 for a box of 24.

The Company has begun its expansion of the Breathe Right product line
with the introduction of Breathe Right Near Clear nasal strips, a nearly
transparent product that the Company believes may help reduce the vanity issues
associated with daytime use of the Breathe Right product. The Company introduced
Breathe Right Near Clear nasal strips in the second half of 1997 and the strips
became available in stores in November.

The Company also intends to introduce additional non-nasal strip
products that carry the Breathe Right name and extend the Breathe Right product
line. Potential new products include a saline nasal spray and allergen barrier
pillow covers.

BANISH PERSONAL SMOKE DEODORIZER. Late in 1997, the Company began
introduction of the BANISH personal smoke deodorizer, a water based nontoxic
odorless spray that removes same day odor from clothes and hair. This product
does not cover up the tobacco smoke odor, it neutralizes it. The product is
available in 2 and 3 fl. oz. bottles and a 12 fl. oz. refill bottle. The Company
intends to begin national advertising of BANISH in the second quarter of 1998.

MARKETS

BREATHE RIGHT PRODUCT LINE. The Breathe Right nasal strip is sold
primarily in the consumer market, and to a lesser extent in the athletic market
and the professional medical market. A substantial number of potential users may
be included in more than one market.

CONSUMER MARKET. Air impedance in the nose accounts for half of the
total airway resistance involved in the respiratory system (i.e., half of the
energy required for breathing). If the effort to breathe through the nose during
sleep is excessive, the person will resort to mouth breathing, promoting
snoring, dry mouth, sore throat and mini-awakenings which disrupt sleep. In
addition, nasal breathing difficulties during sleep are often caused by nasal
congestion found in people with allergies, sinusitis and the common cold and by
nasal obstruction due to a deviated nasal septum. The Company believes that
people with deviated septa or other structural problems or chronic conditions
such as snoring may be more predisposed to use the Breathe Right nasal strip on
a regular or daily basis while seasonal sufferers are likely to use the Breathe
Right nasal strip as needed. People with these medical conditions are currently
the primary users of the product and are the primary targets of the Company's
advertising.

In November 1997, the Company began a focused campaign to increase
Breathe Right product sales in the consumer market, using a Breathe Right. SLEEP
TIGHT (TM). advertising campaign. The new campaign, with its emphasis on better
night time breathing and better sleep, provides an umbrella to point out the
benefits of Breathe Right strips for a variety of large consumer markets.

<PAGE>

* Sleep quality can be enhanced by improving nasal breathing at
night with a Breath Right strip. Nearly 88% of all households
in the United States report nightly sleep disruptions, many of
which are related to poor breathing.

* Breathe Right nasal strips were effective in reducing snoring
loudness or eliminating snoring in 75% of the participants in
a clinical study. The Company believes that 78% of all
households have at least one snorer, and that approximately 37
million people snore regularly while another 50 million people
snore occasionally.

* Nasal congestion as a result of allergies affects
approximately 35 million Americans while substantially all
Americans suffer some nasal congestion annually as a result of
the common cold. The Company believes that the Breathe Right
nasal strip is often used as either an alternative or adjunct
to decongestant drugs (including nasal sprays and oral
decongestants).

* Approximately 12 million people in the United States suffer
from a deviated septum, a bend in the cartilage or bone that
divides the nostrils. Breathe Right strips were cleared by the
Food and Drug Administration in 1996 to provide temporary
relief from breathing difficulties associated with a deviated
septum.

ATHLETIC MARKET. The Company believes that the product may make nasal
breathing more comfortable and may improve endurance during athletic activity,
particularly when a mouth guard is used. An exercise physiology study published
in peer-reviewed medical literature in 1997 concluded that the Breathe Right
nasal strip provided physiologic advantages in ventilation and heart rate during
mid-level exercise. Other exercise physiology studies are being conducted and
are expected to add to substantiation of the positive effects of the Breathe
Right nasal strips during exercise. The Breathe Right nasal strip has been used
by professional and collegiate athletes in sports such as football and hockey,
by race car drivers and horse racing jockeys and by recreational athletes,
including runners and bikers. The Company uses athletes to endorse the Breathe
Right nasal strip to increase the visibility of the product, which thereby leads
to awareness of the product for not only its athletic applications, but also for
snoring, nasal congestion and other applications.

PROFESSIONAL MEDICAL MARKET. The Company also sells Breathe Right nasal
strips to the professional medical market. Sales into this market have been
limited to date and the Company is reevaluating the best way to penetrate this
market.

BANISH PERSONAL SMOKE DEODORIZER. The Company believes there are
approximately 50 million adult smokers in the United States, 16 million of whom
are in positions that involve high interaction with others who could be offended
by smoke odor. There are also a significant number of additional Americans that
do not smoke, but are exposed to smoke in environments such as bars,
restaurants, offices, or factories. The Company believes BANISH has potential
use both for smokers and non-smokers who wish to eliminate tobacco smoke odor.

BUSINESS STRATEGY

The Company's business strategy includes increasing sales of its
Breathe Right nasal strip, expanding its Breathe Right product line and
successfully introducing new products such as BANISH personal smoke deodorizer.

<PAGE>

INCREASING NEW CONSUMER PRODUCT TRIAL AND INCREASING PRODUCT USAGE. The
Company uses a combination of advertising, promotions and celebrity endorsements
to increase consumer awareness of the Breathe Right nasal strip and its benefits
and to encourage consumer trial of the product. During the fourth quarter of
1997, the Company introduced a new advertising campaign Breathe Right. SLEEP
TIGHT., which promotes better sleep through use of Breathe Right nasal strips.
The campaign provides an umbrella to point out the benefits of Breathe Right
strips for a variety of large consumer markets including sleep, snoring, nasal
congestion and a deviated septum. By the end of 1997, household trial of the
Breathe Right nasal strip was approximately 13.5%.

MARKETING NEW PRODUCTS THAT LEVERAGE DISTRIBUTION CHANNELS. The Company
plans to leverage its marketing and distribution strengths by acquiring or
licensing the rights to products that it believes have merit and by attempting
to bring them to market. In late 1997, the Company introduced BANISH personal
smoke deodorizer and plans to begin national advertising in the second quarter
of 1998. Among other products currently being evaluated is a unique, chewable
dietary fiber tablet. Current plans are to introduce this product later in 1998.
There can be no assurance that the Company will ever successfully market any of
the Company's new products.

EXPANDING COMPANY PRESENCE IN INTERNATIONAL MARKET. The Company sells
its Breathe Right nasal strip outside the United States pursuant to an
international distribution agreement under which 3M Company agreed to act as
exclusive distributor for the Breathe Right nasal strip in all counties outside
of the United States and Canada. The Company believes international markets
require an increased level of advertising and promotion to reach their
potential. Under a new arrangement with 3M, the Company and 3M will jointly
undertake a more aggressive advertising and promotional campaign in the United
Kingdom early in 1998. A similar approach is anticipated over the next two to
three years in a number of other countries where both companies believe the
approach could enhance Breathe Right nasal strip sales. This will also allow the
Company to build its international marketing and distribution capacity in
preparation for other Company products.

MARKETING NEW PRODUCTS THAT LEVERAGE THE BREATHE RIGHT BRAND NAME. The
Company believes that the Breathe Right brand name is one of its most valuable
assets. The Company is in the process of evaluating new products that leverage
off the Breathe Right name. Potential products include a saline nasal spray and
allergen barrier pillow covers.

MARKETING STRATEGY

BREATHE RIGHT NASAL STRIPS. The Company began broad consumer marketing
of the Breathe Right nasal strip in September 1994. According to data collected
by Information Resources, Inc. ("IRI"), the Breathe Right nasal strip became a
leading sales volume producer during 1995 in the cough, cold and allergy section
of drug, grocery and mass merchant stores nationwide. In September 1995, the
Company received two REX (retail excellence) awards from Drug Stores News
magazine. The first award named the Breathe Right nasal strip as the best new
product in the cough, cold and allergy section in U.S. drug stores. The second
award named the product the "market maker of the year," the single most
important product which disproportionately increased traffic and profits in U.S.
drug stores. In 1997, the Breathe Right brand was the number one ranking brand
in annual dollar sales in the nasal products category, with sales exceeding
those of familiar brand names such as Afrin(R), Vicks Sinex(R) and Dristan(R).

<PAGE>

The Company's marketing efforts are primarily directed to the consumer
market. The Company's advertising focuses on the snoring and nasal congestion
applications for the product using the campaign Breathe Right. SLEEP TIGHT. The
campaign, with its emphasis on better night time breathing and better sleep,
provides an umbrella for the Company to point out the benefits of Breathe Right
nasal strips for a variety of large consumer markets. The Company primarily uses
a mix of consumer and trade promotions and magazine, radio and television
advertising to market the Breathe Right nasal strip. Marketing communications
are generally designed to promote trial of the Breathe Right nasal strip by
increasing consumer awareness of the product's benefits.

The Company's paid advertising programs have been enhanced by media
coverage of use of Breathe Right nasal strips by professional athletes. In
addition, a number of radio and television personalties have provided
unsolicited endorsements of the product on national radio and television
programs. The Company has also entered into endorsement agreements pursuant to
which athletes will provide the Company with endorsement services. The Company
believes that use by professional athletes increases the visibility of the
product, which thereby leads to greater awareness of the product for not only
its athletic applications but also for snoring, nasal congestion and other
applications, and also makes it more acceptable for consumers to wear the highly
visible product.

The Company also uses product promotion programs, such as coupons, and
public relations activities to encourage product trial and repeat purchases.
Typically, coupons for the Breathe Right nasal strip appear three to four times
each year in free standing inserts (FSIs) that are included in Sunday newspapers
and are often tied to a holiday or special event theme such as Super Bowl,
Fathers Day, or the Christmas holidays (stocking stuffer). In 1997, the Company
undertook joint promotions with two of the nations best-known brand names
KLEENEX (R) tissues, and TYLENOL(R) PM pain reliever. The Company intends to
seek additional joint promotion opportunities in the future. To increase
consumer product awareness, the Company also uses public relations programs
associated with "special events," such as sponsoring marathons, providing
product to certain professional athletic teams and sponsoring radio station
contests in conjunction with certain holidays.

Because the Breathe Right nasal strip is sold as a consumer product,
sales of the product will depend in part upon the degree to which the consumer
is aware of the product and is satisfied with its use, which also influences
repeat usage and word of mouth referrals. The most recent research data
collected by a nationally recognized consumer market research firm indicated
that approximately 32% of those in the U.S. who had purchased Breathe Right
nasal strips have purchased additional product.

BANISH PERSONAL SMOKE DEODORIZER. The Company intends to market its
BANISH personal smoke deodorizer to the consumer market. Similar to its
marketing of Breathe Right nasal strips, the Company intends to use public
relations to launch the BANISH personal smoke deodorizer by making consumers
aware of the product's benefits. Beginning in the second quarter of 1998 the
Company anticipates using a mix of consumer and trade promotions and radio and
magazine advertising to market the product.

DOMESTIC DISTRIBUTION

The Breathe Right nasal strip is sold primarily as a consumer product
in drug stores, grocery stores, mass merchant chain stores, warehouse clubs,
military base stores and convenience stores in the U.S. The Company sells
product to retailers through a network of independent sales representatives
referred to in the

<PAGE>

industry as non-food general merchandise brokers. The Company uses broker groups
who call on the chain drug, grocery, mass merchant and warehouse club accounts
and the wholesalers who serve primarily the independent drug stores and many of
the grocery stores in the U.S.

Although the Company's advertising focuses on both the snoring and
nasal congestion applications, the Breathe Right nasal strip is typically
positioned in the cough, cold and allergy section of the store because Breathe
Right nasal strips provide benefits similar to those obtained with decongestant
products and there is typically no section in stores for snoring relief
products. Many store managers have also placed the product in secondary
locations, such as on the pharmacy counter or in special sections located at the
end of an aisle reserved for better selling products.

The Company's retail customers for the Breathe Right nasal strip
include national chains of drug stores, grocery stores and mass merchants such
as Eckerd, Walgreens, RiteAid, CVS, Albertson's, Kroger, Wal-Mart and Kmart and
warehouse clubs such as Sam's Club and Price Costco, as well as regional and
independent stores in the same store categories. In 1997, one retailer accounted
for approximately 18% of domestic Breathe Right nasal strip sales. The loss of
this customer or any other large retailer would require the Company to replace
the lost sales through other retail outlets and could temporarily disrupt
distribution of the Breathe Right nasal strip.

INTERNATIONAL DISTRIBUTION

The Company executed an international distributor agreement with 3M in
August 1995 pursuant to which 3M has the exclusive right to distribute the
Breathe Right nasal strip outside of the U.S. and Canada. 3M has operations in
over 60 foreign countries. The product is marketed internationally under the
co-brand of "3M Breathe Right nasal strips" in order to benefit from both 3M's
brand name and the publicity that the Breathe Right brand name has received.
Under the terms of the agreement, 3M buys product from the Company either in
finished form in 3M boxes or in bulk quantities to be packaged by 3M's
international subsidiaries. All sales to 3M are denominated in U.S. dollars. 3M
is responsible for obtaining all necessary regulatory approvals outside of the
U.S. and for all marketing and selling expenses. The agreement contains certain
minimum performance objectives and breakup provisions. The product was on retail
shelves in over 40 countries by the end of 1997. The Company is in the process
of negotiating modifications to certain minimum purchase and pricing provisions
of the 3M agreement to enable the Company to take a more active role in sales
and marketing in certain countries.

In 1995, the Company arranged with LOCIN Industries, a Canadian dental
floss company, to establish distribution in the Canadian market. LOCIN
distributes the product to drug stores in Canada. During 1996, LOCIN began
purchasing product in bulk and packaging it at its facility and assumed
responsibility for cooperative advertising programs.

BANISH PERSONAL SMOKE DEODORIZER DISTRIBUTION .

The BANISH personal smoke deodorizer is being sold as a consumer
product with distribution planned initially for drug stores, grocery stores,
mass merchant chain stores and convenience stores. The Company sells product to
retailers through its network of independent sales representatives. The planned
primary location for the product in stores is tobacco accessories.

THERAPATCH (TM) EXTERNAL ANALGESIC PATCH.

<PAGE>

In 1996, the Company began national distribution of the TheraPatch
(TM), an external analgesic patch designed for temporary relief of pain from
arthritis, simple backaches and muscular aches and strains. The Company is not
actively pursuing distribution of the product at the current time and does not
expect to do so in the near future.

NEW PRODUCTS

As a result of the Company's established distribution channels and
highly visible success with the Breathe Right nasal strip, the Company is
frequently approached by individuals and smaller companies to explore the
possibility of partnering with the Company to manufacture and market new product
ideas. The Company routinely evaluates the merit of these products, and from
time to time may acquire or license the rights to products which it believes
could successfully be sold through the Company's established distribution
channels. The Company has entered into contractual arrangements for several
products which are in various stages of evaluation and testing prior to
potential market launch. The Company is currently evaluating a unique, chewable
dietary fiber tablet with plans to introduce this product later in 1998. The
Company plans to incur costs of approximately $1.5 million relating to
evaluation and test marketing of these products in 1998. Most, if not all, of
these products are regulated to varying degrees by the FDA and some will require
extensive clinical studies and regulatory approvals prior to marketing. There
can be no assurance that any required regulatory approvals will be obtained or
that the Company will market any of these products.

MANUFACTURING AND OPERATIONS

The Company currently sub-contracts with multiple manufacturers, known
as converters, to produce the Breathe Right nasal strip and does no in-house
product production itself. The converters are capable of providing full turnkey
service and shipping product to the Company that is completely packaged ready to
be sold to retailers or providing semi-finished goods to the Company that
require final packaging. To complete these products, the Company has the ability
to wrap individual strips in the paper sleeve in-house and subcontracts the
final packaging out to qualified packaging subcontractors.

Each of these converters builds the product to the Company's
specifications using materials specified by the Company and, for the major
materials, places orders against a supply agreement negotiated by the Company
with the material manufacturer. The converters have all entered into
confidentiality agreements with the Company to protect the Company's
intellectual property rights. Company quality control and operations personnel
periodically visit the converters to observe processes and procedures. Finished
goods are inspected at the Company to ensure that they meet quality
requirements. The Company inspects its converters on a regular basis and is not
aware of any material violation of FDA Good Manufacturing Practice Standards.
The Company works closely with its material vendors and converters to reduce
scrap and waste, improve efficiency, and improve yields to reduce the
manufacturing costs of the product. In 1997, the Company received certification
that it has established and maintains a quality system which meets the
requirements of ISO 9002/EN 46002.

To ensure consistent quality and favorable pricing, the Company has
entered into a multi-year material supply agreement with 3M for the major
components of the Breathe Right nasal strip. Although similar materials are
currently available from other suppliers, the Company believes that 3M's
materials are of superior quality. Although the Company believes that this
relationship will not be disrupted or terminated, the inability to obtain
sufficient quantities of these components or the need to develop alternative
sources

<PAGE>

in a timely and cost effective manner could adversely affect the Company's
operations until new sources of these components become available, if at all. In
addition, while the Company does not expect 3M to do so, 3M has the right to
discontinue its production or sale of these products at any time with 90 days
notice to the Company.

The Company has contracted with a third party for the production of the
BANISH personal smoke deodorizer.

COMPETITION

The Company believes that the market for decongestant products is
highly competitive while there is currently somewhat less competition in the
market for products for the reduction or elimination of snoring. In the U.S.,
the Company's competition in the consumer market for decongestant products and
other cold, allergy and sinus relief products consists primarily of
pharmaceutical products while competition in the snoring remedies market consist
primarily of internal nasal dilators. Although the Company believes that the
patents on the Breathe Right nasal strip will somewhat limit the ability of
others to introduce competitive external nasal dilator products in the United
States, the Company announced in 1997 that it had become aware of a foreign
reference to a nasal dilator that will result in narrower protection in the
future for the patents licensed by the Company with respect to Breathe Right
nasal strips. External nasal dilator products also compete in the consumer
markets with decongestant and sinus relief products and snoring remedies in
international markets where the Company does not have patent protection on the
Breathe Right nasal strip. See "Patents, Trademarks and Proprietary Rights"
below. Many of the manufacturers of the pharmaceutical products that compete
with the Breathe Right nasal strip have significantly greater financial and
operating resources than the Company. In addition, competitors may develop
products which are able to circumvent the Company's patents.

GOVERNMENT REGULATION

As a manufacturer and marketer of medical devices, the Company is
subject to regulation by, among other governmental entities, the FDA and the
corresponding agencies of the states and foreign countries in which the Company
sells its products. The Company must comply with a variety of regulations,
including the FDA's Good Manufacturing Practice regulations, and is subject to
periodic inspections by the FDA and applicable state and foreign agencies. If
the FDA believes that its regulations have not been fulfilled, it may implement
extensive enforcement powers, including the ability to ban products from the
market, prohibit the operation of manufacturing facilities and effect recalls of
products from customer locations. The Company believes that it is currently in
compliance with applicable FDA regulations.

FDA regulations classify medical devices into three categories that
determine the degree of regulatory control to which the manufacturer of the
device is subject. In general, Class I devices involve compliance with labeling
and record keeping requirements and are subject to other general controls. Class
II devices are subject to performance standards in addition to general controls.
Class III devices are those devices, usually invasive, for which pre-market
approval (as distinct from pre-market notification) is required before
commercial marketing to assure the products' safety and effectiveness. The
Breathe Right nasal strip has not yet been classified.

Before a new medical device can be introduced into the market, the
manufacturer generally must obtain FDA clearance through either a 510(k)
pre-market notification or a pre-market approval application

<PAGE>

("PMA"). A 510(k) clearance will be granted if the submitted data establish that
the proposed device is "substantially equivalent" to a legally marketed Class I
or II medical device, or to a Class III medical device for which the FDA has not
called for PMAs. The PMA process can be expensive, uncertain and lengthy,
frequently requiring from one to several years from the date the PMA is
accepted. In addition to requiring clearance for new products, FDA rules may
require a filing and waiting period prior to marketing modifications of existing
products. The Company has received 510(k) approvals to market the Breathe Right
nasal strip as a device that can (i) reduce or eliminate snoring, (ii)
temporarily relieve the symptoms of nasal congestion and stuffy nose, (iii)
improve nasal breathing by reducing nasal airflow resistance and (iv)
temporarily relieve breathing difficulties due to a deviated nasal septum.

BANISH personal smoke deodorizer is not a medical product and does not
fall under the regulatory authority of the FDA. It does, however fall under the
purview of the Federal Trade Commission (FTC) as a consumer product. In this
context, the claims that are made concerning BANISH (express or implied) must
have a reasonable basis before they are disseminated. The Company believes that
it has a reasonable basis for all claims it is making with respect to BANISH.

The Company's proposed dietary fiber product is considered to be a
dietary supplement and is regulated under the Federal Food, Drug, and Cosmetic
Act (the Act) as amended by the Dietary Supplement Health and Education Act
"DSHEA" of 1994, and under the Fair Packaging and Labeling Act. There is
generally no requirement that a firm obtain a license or approval from FDA
before marketing dietary supplements in the U.S. The FDA is developing
implementing regulations for certain provisions of the DSHEA which will be
published as final rules in the Federal Register.

In addition to the Company's medical device products, the Company has
entered into an agreement to manufacture and market a smoking substitute and
appetite suppressant product that the FDA may classify as either a "New Drug" or
as a dietary supplement. The FDA must approve safety and effectiveness for each
labeled use before a New Drug can be sold. As part of the requirements for
obtaining approval of a New Drug, the Company will be required to conduct
extensive preclinical studies to determine the safety and efficacy of the drug.
Upon completion of these studies, the Company will submit an Investigational New
Drug application ("IND") to the FDA, which permits the Company to begin clinical
trials.

These clinical trials of the products must be conducted and the results
submitted to the FDA as part of a New Drug Application ("NDA"). The FDA must
approve the NDA before pharmaceutical products may be sold in the U.S. The grant
of regulatory approvals often takes a number of years and may involve the
expenditure of substantial resources. There is no assurance that NDAs will be
approved for the Company's products if any are required. Even after initial FDA
approval has been granted, further studies may be conducted to provide
additional data on safety or efficacy or to obtain approval for marketing the
drug as a treatment for disease indications in addition to those originally
approved. In addition, the FDA can revoke its approval even after it has
initially been given.

Sales of the Company's products outside the U.S. are subject to
regulatory requirements governing human clinical trials and marketing approval
for drugs, and such requirements vary widely from country to country. Under its
current agreement with the Company, which is as noted above under "International
Distribution" in the process of being renegotiated, 3M is responsible for
obtaining all necessary regulatory approvals outside the U.S. for Breathe Right
nasal strips. The Company believes it has provided 3M with the necessary
documentation to enable 3M to obtain the "CE" mark, an international symbol of
quality and

<PAGE>

compliance with applicable European medical device directives, and 3M is
affixing the CE mark on the Company's products in Europe.

No assurance can be given that the FDA or state or foreign regulatory
agencies will give on a timely basis, if at all, the requisite approvals or
clearances for additional applications for the Breathe Right nasal strip or for
any of the Company's products which are under development. Moreover, after
clearance is given, the Company is required to advise the FDA and these other
regulatory agencies of modifications to its products. These agencies have the
power to withdraw the clearance or require the Company to change the device or
its manufacturing process or labeling, to supply additional proof of its safety
and effectiveness or to recall, repair, replace or refund the cost of the
medical device if it is shown to be hazardous or defective. The process of
obtaining clearance to market products is costly and time-consuming and can
delay the marketing and sale of the Company's products. Furthermore, federal,
state and foreign regulations regarding the manufacture and sale of medical
devices are subject to future change. The Company cannot predict what impact, if
any, such changes might have on its business.

The Company is also subject to substantial federal, state and local
regulation regarding occupational health and safety, environmental protection,
hazardous substance control and waste management and disposal, among others.

PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS

The Company entered into a license agreement in 1992 (the "License
Agreement") pursuant to which the Company acquired from the licensor (the
"Licensor") the exclusive rights to manufacture and sell the Breathe Right nasal
strip. Specifically, the Company has the exclusive right pursuant to the License
Agreement to manufacture, sell and otherwise practice any invention, including
the Breathe Right nasal strip, claimed in the Licensor's patent applications
related thereto and all patents issued in any country which correspond to those
applications. The Company must pay royalties to the Licensor based on sales of
the Breathe Right nasal strip including certain minimum royalty amounts to
maintain its exclusivity. The Company is also responsible for all costs and
expenses incurred in obtaining and maintaining patents related to the Breathe
Right nasal strip.

The Licensor has filed patent applications with the U.S. Patent and
Trademark Office seeking patent protection for different aspects of the Breathe
Right nasal strip technology. Six of these patent applications have resulted in
issued patents, including one with claims that cover the single-body
construction of the Breathe Right nasal strip. The Company has one patent
application pending. The Licensor has also obtained patent protection on the
Breathe Right nasal strip in three foreign countries and has various
applications pending which seek patent protection in a number of additional
countries.

There can be no assurance that the Licensor's patents on the Breathe
Right nasal strip, or any additional patents issued, if any, will effectively
foreclose the development of competitive products or that the Company will have
sufficient resources to pursue enforcement of any patents issued. See Item 3,
Legal Proceedings. The Company intends to aggressively enforce the patents
covering the Breathe Right nasal strip. In order to enforce any patents issued
covering the Breathe Right nasal strip, the Company may have to engage in
litigation, which may result in substantial cost to the Company and
counterclaims against the Company. Any adverse outcome of such litigation could
have a negative impact on the Company's business. In 1997, the Company became
aware of a foreign reference to a nasal dilator that will result in narrower

<PAGE>

protection than originally expected from the patents being licensed by the
Company with respect to Breathe Right nasal strips. In addition, in February
1998, the Company was notified by Acutek Adhesive Specialities, Inc. ("Acutek")
that Acutek or one or its affiliates will make or sell nasal dilators in the
United States and certain other markets. Acutek and the Company are engaged in
patent litigation on which settlement discussions are pending. See Item 3, Legal
Proceedings.

The Company has registered its Breathe Right trademark in the United
States and in several foreign countries and is seeking registration of its other
trademarks. The Company believes its trademarks are important as protection for
the Company's names and advertising, and intends to take such steps as are
necessary to protect these trademarks.

There can be no assurance that the Company's technology will not be
challenged on the grounds that the Company's products infringe on patents,
copyrights or other proprietary information owned or claimed by others or that
others will not successfully utilize part or all of the Company's technology
without compensation to the Company. In addition to seeking patent protection
for its products, the Company intends to also protect its technologies and
proprietary information as trade secrets.

EMPLOYEES

At March 3, 1998, the Company had 50 full-time and two part-time
employees, of whom 14 were engaged in operations, 19 in general administration,
17 in marketing and sales and two in product development. There are no unions
representing Company employees. Relations with its employees are believed to be
positive and there are no pending or threatened labor employment disputes or
work interruptions.

EXECUTIVE OFFICERS OF THE COMPANY

The following table sets forth the names and ages of the Company's
Executive Officers together with all positions and offices held with the Company
by such Executive Officers. Officers are appointed to serve until the meeting of
the Board of Directors following the next Annual Meeting of Shareholders and
until their successors have been elected and have qualified.

Name and Age Office
------------ ------

Daniel E. Cohen, M.D.(45) Chairman of the Board, Chief Executive Officer,
Treasurer and Director

Marti Morfitt(40) President, Chief Operating Officer and Director

M. W. Anderson, Ph.D.(47) Vice President of Clinical and Regulatory Affairs

David J. Byrd(44) Vice President of Finance and Chief Financial Officer

William Doubek(42) Vice President of Operations

Rihab FitzGerald(46) Vice President of Consumer Sales

Kirk P. Hodgdon(38) Vice President of Consumer Marketing

<PAGE>

Gerhard Tschautscher(41) Vice President of International and Professional
Medical Marketing

DANIEL E. COHEN, M.D. has served as the Company's Chairman of the Board
since 1993, its Chief Executive Officer since 1989 and a director and the
Treasurer since 1982. Dr. Cohen was a founder of the Company and is a
board-certified neurologist.

MARTI MORFITT, has agreed to serve as the Company's President and Chief
Operating Officer and a director beginning March 30, 1998. From September 1982
through February 1998, Ms. Morfitt served in a series of positions of increasing
responsibility with the Pillsbury Company, a Minneapolis-based manufacturer and
distributor of food products, most recently serving from May 1997, to February
1998, as Vice-President, Meals, and from February 1994, to May 1997, as
Vice-President, Green Giant Brands. She also serves as a director of Graco,
Inc., a Minneapolis-based manufacturer of fluid handling systems.

M. W. ANDERSON, PH.D. has served as the Company's Vice President of
Clinical and Regulatory Affairs and Vice President of Research and Development
since 1990. He has served in various capacities since joining the Company in
1984, including Director of Applications Research and Director of Research and
Development. Prior to joining the Company in 1984, Dr. Anderson was an Assistant
Professor at the University of Minnesota's College of Pharmacy.

DAVID J. BYRD has served as the Company's Vice President of Finance and
Chief Financial Officer since February 1996. Prior to joining the Company, Mr.
Byrd was Chief Financial Officer and Treasurer of Medisys, Inc., a health care
services company, since 1991. From 1975 to 1991, Mr. Byrd was employed by
Coopers & Lybrand, where he was a partner from 1986 to 1991. Mr. Byrd is a
certified public accountant.

WILLIAM DOUBEK has served as the Company's Vice President of Operations
since 1990, Director of Operations from 1986 to 1990 and was the Company's
Senior Engineer from 1982 to 1986. Prior to joining the Company in 1982, Mr.
Doubek served as Senior Project Engineer at Medtronic, Inc., a manufacturer of
medical devices, Senior Engineer at Micro Control Company, a manufacturer of
computer testing equipment, and Electrical Engineer at Palico Instrument
Company, a manufacturer of computer testing equipment.

RIHAB FITZGERALD has served as the Company's Vice President of Consumer
Sales since August 1993, Vice President of Sales and Marketing from 1990 to
August 1993 and Director of Marketing from 1985 to 1990. Prior to joining the
Company in 1984, Ms. Fitzgerald was employed in sales and marketing with Nicolet
Instrument Corporation, a medical devices manufacturer.

KIRK P. HODGDON has been the Company's Vice President of Marketing
since February 1994. Prior to joining the Company, Mr. Hodgdon served as: Vice
President-Management Supervisor at Gage Marketing Communications, a marketing
services company, from 1993 to February 1994; Vice President - Account
Supervisor at U.S. Communications, a marketing agency, from 1989 to 1993; and
Marketing Manager at Land O'Lakes, Inc., a consumer foods cooperative, from 1988
to 1989.

GERHARD TSCHAUTSCHER has served as the Company's Vice President of
International and Professional Medical Marketing since January 1994 and as a
Company Product Director and as the International Sales Marketing and Sales
Director between 1988 and December 1993.

<PAGE>

ITEM 2. PROPERTIES

The Company leases approximately 80,000 square feet of office,
manufacturing and warehouse space in Bloomington, Minnesota. The lease expires
in December 2000. The Company also leases approximately 32,000 square feet of
warehouse space on a month to month basis.

ITEM 3. LEGAL PROCEEDINGS

Except as otherwise disclosed in this Form 10-K, no material legal
proceedings are pending or known to be contemplated to which the Company is a
party or to which any of its property is subject, and the Company knows of no
material legal proceedings pending or threatened, or judgments against any
director or officer of the Company in his or her capacity as such.

In January 1997, the Company was sued for patent infringement in the
United States District Court for the Central District of California by Acutek
Adhesive Specialties, Inc. ("Acutek"). Acutek claims to be an exclusive licensee
in the United States Reissue Patent RE. 35,408. The plaintiff seeks compensatory
damages, interest, costs and fees. The Company has counterclaimed for a
declaration of invalidity of the patents asserted by Acutek and for a
declaration that the Company does not infringe the Reissue Patent. Cross-motions
for summary judgment with respect to the lawsuit are pending. In February 1998,
Acutek was issued a patent entitled "Transparent Nasal Dilator" and commenced an
additional patent infringement lawsuit against the Company in the United States
District Court for the Central District of California. The Company believes that
it does not infringe any valid patent claims and has vigorously defended the
lawsuits brought against it by Acutek. The Company is engaged in settlement
negotiations, however, that may resolve all pending matters between the parties.
The Company is currently unable to determine if these discussions will
ultimately result in a settlement.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

<PAGE>

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

Information as to the principal market on which the Company's common
stock is traded and market price information for the common stock of the Company
is incorporated herein by reference from page 20 of the 1997 Annual Report to
Shareholders (the "1997 Annual Report").

On March 3, 1998, the last sale price of the Common Stock as reported
on the NASDAQ National Market was $6.3125. As of March 3, 1998, there were
approximately 850 owners of record of Common Stock.

The Company has never paid any dividends on its Common Stock. The
Company currently intends to retain any earnings for use in its operations and
does not anticipate paying any cash dividends in the foreseeable future. The
payment of dividends, if any, in the future will be at the discretion of the
Board of Directors and will depend upon, among other things, future earnings,
capital requirements, restrictions in future financing agreements, the general
financial condition of the Company and general business considerations.

ITEM 6. SELECTED FINANCIAL DATA

Selected financial information is presented on page 1 of the Company's
1997 Annual Report and is incorporated herein by reference.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and
Results of Operations appears on pages 8 through 12 of the Company's 1997 Annual
Report and is incorporated herein by reference.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Balance Sheets of the Company as of December 31, 1996 and 1997,
and the related Statements of Income, Stockholders' Equity and Cash Flows for
each of the years in the three-year period ended December 31, 1997, the Notes to
the Financial Statements and the Report of KPMG Peat Marwick LLP, independent
auditors, is contained in the Company's 1997 Annual Report on pages 13 through
20 and is incorporated herein by reference.

<PAGE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

<PAGE>

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Certain information required under this Item with respect to
directors is contained in the Section "Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement for
the Annual Meeting of Shareholders to be held on April 22, 1998 (the "1998 Proxy
Statement"), a definitive copy of which will be filed with the Commission within
120 days of the close of the last fiscal year, and is incorporated herein by
reference.

Information concerning executive officers is set forth in the Section
entitled "Executive Officers of the Company" in Part I of this Form 10-K
pursuant to Instruction 3 to paragraph (b) of Item 401 of Regulation S-K.

ITEM 11. EXECUTIVE COMPENSATION

Information required under this item is contained in the section
entitled "Executive Compensation" in the 1998 Proxy Statement and is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required under this item is contained in the section
entitled "Security Ownership of Principal Stockholders and Management" in the
Company's 1998 Proxy Statement and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not applicable.

<PAGE>

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

a. Documents filed as part of this Report:

1. Financial Statements. See Item 8, Financial Statements.

2. Financial Statement Schedules. Not Applicable.

3. Exhibits. See "Exhibit Index" on the page following the
Signature Page.

b. Reports on Form 8-K. The Company did not file a report on Form 8-K
during the fourth quarter ended December 31, 1997.

<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

CNS, INC.
("Registrant")

Dated: March 27, 1998 By/s/ Daniel E. Cohen
--------------------
Daniel E. Cohen, M.D.
Chairman of the Board, Chief Executive Officer,
Treasurer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed by the following persons on March 27, 1998 on behalf
of the Registrant in the capacities indicated.

(Power of Attorney)

Each person whose signature appears below constitutes and appoints
DANIEL E. COHEN, M.D. and PATRICK DELANEY as his true and lawful
attorneys-in-fact and agents, each acting alone, with the full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any or all amendments to this Annual Report on
Form 10-K and to file the same, with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, each acting alone, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all said
attorneys-in-fact and agents, each acting alone, or his substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.

/s/ Daniel E. Cohen, M.D.
Daniel E. Cohen, M.D.
Chairman of the Board and Chief
Executive Officer, Treasurer and Director
(Principal Executive Officer)

/s/David J. Byrd
David J. Byrd
Vice President of Finance and Chief
Financial Officer
(Principal Financial and Accounting Officer)

<PAGE>

/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

<PAGE>

CNS, INC.
EXHIBIT INDEX

Exhibit No. Description
- ----------- -----------

3.1 Company's Certificate of Incorporation as amended to date
(incorporated by reference to Exhibit 3.1 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1995 (the "1995 Form 10-K").

3.2 Company's Amended By-Laws (incorporated by reference to
Exhibit 3.2 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1991 (the "1991 Form 10-K")).

10.1 * CNS, Inc. 1987 Employee Incentive Stock Option Plan
(incorporated by reference to Exhibit 10.1 to the Company's
Registration Statement on Form S-18, Commission File No.
33-14052C).

10.2 * CNS, Inc. 1989 Employee Stock Purchase Plan (incorporated by
reference to Exhibit 10.9 to the Company's Registration
Statement on Form S-8, Commission File No. 33-29454).

10.3 * CNS, Inc. 1990 Stock Plan (incorporated by reference to
Exhibit 10.11 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1990).

10.4 License Agreement dated January 30, 1992 between the Company
and Creative Integration and Design, Inc. (incorporated by
reference to Exhibit 10.11 to the 1992 Form S-2).

10.5 * CNS, Inc. 1994 Amended Stock Plan.

10.6 Distribution Agreement dated August 2, 1995 between the
Company and Minnesota Mining and Manufacturing Company ("3M")
(incorporated by reference to Exhibit 10.11 to the 1995 Form
10-K).

10.7 Supply Agreement dated May 17, 1995 between the Company and
Minnesota Mining and Manufacturing Company ("3M") incorporated
by reference to Exhibit 10.12 to the 1995 Form 10-K).

10.8 License Agreement dated January 24, 1996 between the Company
and Ronald S. Nietupsky (incorporated by reference to Exhibit
10.15 to the 1995 Form 10-K).

10.9 License Agreement dated May 9, 1997 between the Company and
Cigone, Enterprises, SmokeBusters of Texas, Inc. and Odor
Pros, Inc. (Certain information has been omitted from this
Exhibit and filed separately with the SEC pursuant to a
request for confidential treatment under Rule 24b-2.)

<PAGE>

10.10 * Employment Agreement between the Company and Dr. Daniel E.
Cohen dated April 15, 1996, (incorporated by reference to
Exhibit 10.15 to 1996 Form 10-K).

10.11 * Employment Agreement dated April 15, 1996 between the Company
and Kirk Hodgdon (incorporated by reference to Exhibit 10.17
to 1996 Form 10-K).

10.12 * Employment Agreement dated April 15, 1996 between the Company
and David J. Byrd (incorporated by reference to Exhibit 10.18
to 1996 Form 10-K).

11.1 Computation of Net Income Per Share of Common Stock.

13.1 Selected information from 1997 Annual Report to Stockholders

21.1 Subsidiaries of the Company

23.1 Consent of KPMG Peat Marwick LLP.

24.1 Powers of Attorney (included on the signature page hereof).

27.1 Financial Data Schedule.

27.2 Financial Data Schedule.

27.3 Financial Data Schedule.
- ---------------

* Indicates Compensatory Agreement

CNS, INC.
1994 AMENDED STOCK PLAN

<PAGE>

TABLE OF CONTENTS

PAGE
----

SECTION 1. General Purpose of Plan; Definitions..................... 1

SECTION 2. Administration........................................... 3

SECTION 3. Stock Subject to Plan.................................... 4

SECTION 4. Eligibility.............................................. 5

SECTION 5. Stock Options............................................ 5

SECTION 6. Stock Appreciation Rights................................ 9

SECTION 7. Restricted Stock.........................................10

SECTION 8. Deferred Stock Awards....................................11

SECTION 9. Other Awards. ..........................................12

SECTION 10. Transfer, Leave of Absence, etc......................... 13

SECTION 11. Amendments and Termination.............................. 13

SECTION 12. Unfunded Status of Plan................................. 13

SECTION 13. General Provisions...................................... 14

SECTION 14. Effective Date of Plan.................................. 15

<PAGE>

CNS, INC.
1994 AMENDED STOCK PLAN

SECTION 1. General Purpose of Plan; Definitions.

The name of this plan is the CNS, Inc. 1994 Amended Stock Plan (the
"Plan"). The purpose of the Plan is to enable CNS, Inc. (the "Company") and its
Subsidiaries to retain and attract executives, other key employees and members
of the Board of Directors who contribute to the Company's success by their
ability, ingenuity and industry, and to enable such individuals to participate
in the long-term success and growth of the Company by giving them a proprietary
interest in the Company.

For purposes of the Plan, the following terms shall be defined as set
forth below:

a. "Agreement" means an agreement by and between the Company and
an optionee or recipient of an award under the Plan setting
forth the terms and conditions of the option or award.

b. "Board" means the Board of Directors of the Company.

c. "Cause" means a felony conviction of a participant or the
failure of a participant to contest prosecution for a felony,
or a participant's willful misconduct or dishonesty, any of
which is directly and materially harmful to the business or
reputation of the Company.

d. "Code" means the Internal Revenue Code of 1986, as amended
from time to time, or any successor statute.

e. "Committee" means the Committee referred to in Section 2 of
the Plan. If at any time no Committee shall be in office, then
the functions of the Committee specified in the Plan shall be
exercised by the Board, unless the Plan specifically states
otherwise.

f. "Company" means CNS, Inc., a corporation organized under the
laws of the State of Delaware (or any successor corporation).

g. "Deferred Stock" means an award made pursuant to Section 8
below of the right to receive Stock at the end of a specified
deferral period.

h. "Disability" means total and permanent disability as
determined by the Committee.

<PAGE>

i. "Early Retirement" means retirement, with consent of the
Committee at the time of retirement, from active employment
with the Company and any Subsidiary or Parent Corporation of
the Company.

j. "Fair Market Value" of Stock on any given date shall be
determined by a Committee as follows: (a) if the Stock is
listed for trading on one or more national securities
exchanges, or is traded on the Nasdaq Stock Market, the last
reported sales price on the principal such exchange or the
Nasdaq Stock Market on the date in question, or if such Stock
shall not have been traded on such principal exchange on such
date, the last reported sales price on such principal exchange
or the Nasdaq Stock Market on the first day prior thereto on
which such Stock was so traded; or (b) if the Stock is not
listed for trading on a national securities exchange or the
Nasdaq Stock Market, but is traded in the over-the-counter
market, including the Nasdaq Small Cap Market, the closing bid
price for such Stock on the date in question, or if there is
no such bid price for such Stock on such date, the closing bid
price on the first day prior thereto on which such price
existed; or (c) if neither (a) nor (b) is applicable, by any
means fair and reasonable by the Committee, which
determination shall be final and binding on all parties.

k. "Incentive Stock Option" means any Stock Option intended to be
and designated as an "Incentive Stock Option" within the
meaning of Section 422 of the Code.

l. "Non-Employee Director" means a "Non-Employee Director" within
the meaning of Rule 16b-3 under the Securities Exchange Act of
1934.

m. "Non-Qualified Stock Option" means any Stock Option that is
not an Incentive Stock Option, and is intended to be and is
designated as a "Non-Qualified Stock Option."

n. "Normal Retirement" means retirement from active employment
with the Company and any Subsidiary or Parent Corporation of
the Company on or after age 60.

o. "Other Awards" means those awards granted pursuant to Section
9 hereof.

p. "Outside Director" means a Director who: (a) is not a current
employee of the Company or any member of an affiliated group
which includes the Company; (b) is not a former employee of
the Company who receives compensation for prior services
(other than benefits under a tax-qualified retirement plan)
during the taxable year; (c) has not been an officer of the
Company; (d) does not receive remuneration from the Company,
either directly or indirectly, in any capacity other than as a
director, except as otherwise permitted under Code Section
162(m) and regulations thereunder. For this purpose,
remuneration includes any payment in exchange for goods or
services. This definition shall be further governed by the
provisions of Code Section 162(m) and regulations promulgated
thereunder.

<PAGE>

q. "Parent Corporation" means any corporation (other than the
Company) in an unbroken chain of corporations ending with the
Company if each of the corporations (other than the Company)
owns stock possessing 50% or more of the total combined voting
power of all classes of stock in one of the other corporations
in the chain.

r. "Restricted Stock" means an award of shares of Stock that are
subject to restrictions under Section 7 below.

s. "Retirement" means Normal Retirement or Early Retirement.

t. "Stock" means the Common Stock, $.01 par value per share, of
the Company.

u. "Stock Appreciation Right" means the right pursuant to an
award granted under Section 6 below to surrender to the
Company all or a portion of a Stock Option in exchange for an
amount equal to the difference between (i) the Fair Market
Value, as of the date such Stock Option or such portion
thereof is surrendered, of the shares of Stock covered by such
Stock Option or such portion thereof, and (ii) the aggregate
exercise price of such Stock Option or such portion thereof.

v. "Stock Option" means any option to purchase shares of Stock
granted pursuant to Section 5 below.

w. "Subsidiary" means any corporation (other than the Company) in
an unbroken chain of corporations beginning with the Company
if each of the corporations (other than the last corporation
in the unbroken chain) owns stock possessing 50% or more of
the total combined voting power of all classes of stock in one
of the other corporations in the chain.

SECTION 2. Administration.

The Plan shall be administered by the Board of Directors or by a
Committee appointed by the Board of Directors of the Company consisting of at
least two Directors, all of whom shall be Outside Directors and Non-Employee
Directors, who shall serve at the pleasure of the Board.

The Committee shall have the power and authority to grant to eligible
employees and members of the Board, pursuant to the terms of the Plan: (i) Stock
Options, (ii) Stock Appreciation Rights, (iii) Restricted Stock, (iv) Deferred
Stock awards, or (v) Other Awards.

In particular, the Committee shall have the authority:

(i) to select the members of the Board, officers and
other key employees of the Company and its
Subsidiaries and other eligible persons to whom Stock

<PAGE>

Options, Stock Appreciation Rights, Restricted Stock,
Deferred Stock awards and/or Other Awards may from
time to time be granted hereunder;

(ii) to determine whether and to what extent Incentive
Stock Options, NonQualified Stock Options, Stock
Appreciation Rights, Restricted Stock, Deferred Stock
awards and/or Other Awards, or a combination of the
foregoing, are to be granted hereunder;

(iii) to determine the number of shares to be covered by
each such award granted hereunder;

(iv) to determine the terms and conditions, not
inconsistent with the terms of the Plan, of any award
granted hereunder (including, but not limited to, any
restriction on any Stock Option or other award and/or
the shares of Stock relating thereto), which
authority shall be exclusively vested in the
Committee (and not the Board) for purposes of
establishing performance criteria used with
Restricted Stock and Deferred Stock awards and Other
Awards; provided, however, that in the event of a
merger or asset sale, the applicable provisions of
Sections 5(c) and 7(c) of the Plan shall govern the
acceleration of vesting of any Stock Option or
awards; and

(v) to determine whether, to what extent and under what
circumstances Stock and other amounts payable with
respect to an award under this Plan shall be deferred
either automatically or at the election of the
participant.

The Committee shall have the authority to adopt, alter and repeal such
administrative rules, guidelines and practices governing the Plan as it shall,
from time to time, deem advisable; to interpret the terms and provisions of the
Plan and any award issued under the Plan (and any agreements relating thereto);
and to otherwise supervise the administration of the Plan. The Committee may
delegate to executive officers of the Company the authority to exercise the
powers specified in (i), (ii), (iii), (iv) and (v) above with respect to persons
who are not either the chief executive officer of the Company or the four
highest paid officers of the Company other than the chief executive officer.

All decisions made by the Committee pursuant to the provisions of the
Plan shall be final and binding on all persons, including the Company and Plan
participants.

SECTION 3. Stock Subject to Plan.

The total number of shares of Stock reserved and available for
distribution under the Plan shall be 1,750,000. Such shares may consist, in
whole or in part, of authorized and unissued shares.

<PAGE>

Subject to paragraph (b)(iv) of Section 6 below, if any shares that
have been optioned ceased to be subject to Stock Options, or if any shares
subject to any Restricted Stock or Deferred Stock award or Other Award granted
hereunder are forfeited or such award otherwise terminates without a payment
being made to the participant, such shares shall again be available for
distribution in connection with future awards under the Plan.

In the event of any merger, reorganization, consolidation,
recapitalization, stock dividend, stock split, other change in corporate
structure affecting the Stock, or spin-off or other distribution of assets to
shareholders, such substitution or adjustment shall be made in the aggregate
number of shares reserved for issuance under the Plan, in the number and option
price of shares subject to outstanding options granted under the Plan, and in
the number of shares subject to Restricted Stock or Deferred Stock awards
granted under the Plan as may be determined to be appropriate by the Committee,
in its sole discretion, provided that the number of shares subject to any award
shall always be a whole number. Such adjusted option price shall also be used to
determine the amount payable by the Company upon the exercise of any Stock
Appreciation Right associated with any Option.

SECTION 4. Eligibility.

Officers, other key employees of the Company and Subsidiaries and
members of the Board who are responsible for or contribute to the management,
growth and/or profitability of the business of the Company and its Subsidiaries
are eligible to be granted Stock Options, Stock Appreciation Rights, Restricted
Stock or Deferred Stock awards or Other Awards under the Plan. The optionees and
participants under the Plan shall be selected from time to time by the
Committee, in its sole discretion, from among those eligible, and the Committee
shall determine, in its sole discretion, the number of shares covered by each
award.

Notwithstanding the foregoing, no person shall receive awards under
this Plan which exceed 150,000 shares during any fiscal year of the Company.

SECTION 5. Stock Options.

Any Stock Option granted under the Plan shall be in such form as the
Committee may from time to time approve.

The Stock Options granted under the Plan may be of two types: (i)
Incentive Stock Options and (ii) Non-Qualified Stock Options. No Incentive Stock
Options shall be granted under the Plan after June 17, 2004.

The Committee shall have the authority to grant any optionee Incentive
Stock Options, NonQualified Stock Options, or both types of options (in each
case with or without Stock Appreciation Rights). To the extent that any option
does not qualify as an Incentive Stock Option, it shall constitute a separate
Non-Qualified Stock Option.

<PAGE>

Anything in the Plan to the contrary notwithstanding, no term of this
Plan relating to Incentive Stock Options shall be interpreted, amended or
altered, nor shall any discretion or authority granted under the Plan be so
exercised, so as to disqualify either the Plan or any Incentive Stock Option
under Section 422 of the Code. The preceding sentence shall not preclude any
modification or amendment to an outstanding Incentive Stock Option, whether or
not such modification or amendment results in disqualification of such Option as
an Incentive Stock Option, provided the optionee consents in writing to the
modification or amendment.

Options granted under the Plan shall be subject to the following terms
and conditions and shall contain such additional terms and conditions, not
inconsistent with the terms of the Plan, as the Committee shall deem desirable.

(a) Option Price. The option price per share of Stock purchasable under
a Stock Option shall be determined by the Committee at the time of grant. In no
event shall the option price per share of Stock purchasable under an Incentive
Stock Option or a Non-Qualified Stock Option be less than 100% of the Fair
Market Value of the Stock on the date of the option is granted. If an employee
owns or is deemed to own (by reason of the attribution rules applicable under
Section 424(d) of the Code) more than 10% of the combined voting power of all
classes of stock of the Company or any Parent Corporation or Subsidiary and an
Incentive Stock Option is granted to such employee, the option price shall be no
less than 110% of the Fair Market Value of the Stock on the date the option is
granted.

(b) Option Term. The term of each Stock Option shall be fixed by the
Committee, but no Incentive Stock Option shall be exercisable more than ten
years after the date the option is granted. If an employee owns or is deemed to
own (by reason of the attribution rules of Section 424(d) of the Code) more than
10% of the combined voting power of all classes of stock of the Company or any
Parent Corporation or Subsidiary and an Incentive Stock Option is granted to
such employee, the term of such option shall be no more than five years from the
date of grant.

(c) Exercisability. Stock Options shall be exercisable at such time or
times as determined by the Committee at or after grant, subject to the
restrictions stated in Section 5(b) above. If the Committee provides, in its
discretion, that any option is exercisable only in installments, the Committee
may waive such installment exercise provisions at any time. Notwithstanding
anything contained in the Plan to the contrary, the Committee may, in its
discretion extend or vary the term of any Stock Option or any installment
thereof, whether or not the optionee is then employed by the Company, if such
action is deemed to be in the best interests of the Company; provided, however,
that in the event of a merger or sale of assets, the provisions of this Section
5(c) shall govern vesting acceleration. Notwithstanding the foregoing, unless
the Stock Option Agreement provides otherwise, any Stock Option granted under
this Plan shall be exercisable in full, without regard to any installment
exercise provisions, for a period specified by the Committee, but not to exceed
sixty (60) days prior to or subsequent to the occurrence of any of the following
events: (i) dissolution or liquidation of the Company other than in conjunction
with a bankruptcy of the Company or any similar occurrence, (ii) any merger,
consolidation, acquisition, separation, reorganization, or similar

<PAGE>

occurrence, where the Company will not be the surviving entity or (iii) the
transfer of substantially all of the assets of the Company or 20% or more of the
outstanding Stock of the Company.

The grant of an option pursuant to the Plan shall not limit in any way
the right or power of the Company to make adjustments, reclassifications,
reorganizations or changes of its capital or business structure or to merge,
exchange or consolidate or to dissolve, liquidate, sell or transfer all or any
part of its business or assets.

(d) Method of Exercise. Stock Options may be exercised in whole or in
part at any time during the option period by giving written notice of exercise
to the Company specifying the number of shares to be purchased. Such notice
shall be accompanied by payment in full of the purchase price, either by
certified or bank check, or by any other form of legal consideration deemed
sufficient by the Committee and consistent with the Plan's purpose and
applicable law, including promissory notes or a properly executed exercise
notice together with irrevocable instructions to a broker acceptable to the
Company to promptly deliver to the Company the amount of sale or loan proceeds
to pay the exercise price. As determined by the Committee, in its sole
discretion, payment in full or in part may also be made in the form of Stock
already owned by the optionee (which in the case of Stock acquired upon exercise
of an option have been owned for more than six months on the date of surrender)
or, in the case of the exercise of a Non-Qualified Stock Option, Restricted
Stock or Deferred Stock subject to an award hereunder (based, in each case, on
the Fair Market Value of the Stock on the date immediately preceding the date
the option is exercised, as determined by the Committee), provided, however,
that, in the case of an Incentive Stock Option, the right to make a payment in
the form of already owned shares may be authorized only at the time the option
is granted, and provided further that in the event payment is made in the form
of shares of Restricted Stock or a Deferred Stock award, the optionee will
receive a portion of the option shares in the form of, and in an amount equal
to, the Restricted Stock or Deferred Stock award tendered as payment by the
optionee. If the terms of an option so permit, an optionee may elect to pay all
or part of the option exercise price by having the Company withhold from the
shares of Stock that would otherwise be issued upon exercise that number of
shares of Stock having a Fair Market Value equal to the aggregate option
exercise price for the shares with respect to which such election is made. No
shares of Stock shall be issued until full payment therefor has been made. An
optionee shall generally have the rights to dividends and other rights of a
shareholder with respect to shares subject to the option when the optionee has
given written notice of exercise, has paid in full for such shares.

(e) Non-transferability of Options. No Stock Option shall be
transferable by the optionee otherwise than by will or by the laws of descent
and distribution, and all Stock Options shall be exercisable, during the
optionee's lifetime, only by the optionee.

(f) Termination by Death. If an optionee's employment by the Company
and any Subsidiary or Parent Corporation terminates by reason of death, the
Stock Option may thereafter be immediately exercised, to the extent then
exercisable (or on such accelerated basis as the Committee shall determine at or
after grant), by the legal representative of the estate or by the legatee of the
optionee under the will of the optionee, for a period of three months (or such
shorter period as the

<PAGE>

Committee shall specify at grant) from the date of such death or until the
expiration of the stated term of the option, whichever period is shorter. In the
event of termination of employment by reason of death, if any Stock Option is
exercised after the expiration of the exercise periods that apply for purposes
of Section 422 of the Code, the option will thereafter be treated as a
Non-Qualified Stock Option.

(g) Termination by Reason of Disability. If an optionee's employment by
the Company and any Subsidiary or Parent Corporation terminates by reason of
Disability, any Stock Option held by such optionee may thereafter be exercised,
to the extent it was exercisable at the time of termination due to Disability
(or on such accelerated basis as the Committee shall determine at or after
grant), but may not be exercised after one year (or such shorter period as the
Committee shall specify at grant) from the date of such termination of
employment or the expiration of the stated term of the option, whichever period
is the shorter. In the event of termination of employment by reason of
Disability, if an Incentive Stock Option is exercised after the expiration of
the exercise periods that apply for purposes of Section 422 of the Code, the
option will thereafter be treated as a NonQualified Stock Option.

(h) Termination by Reason of Retirement. If an optionee's employment by
the Company and any Subsidiary or Parent Corporation terminates by reason of
Retirement and the terms of the Stock Option so provide, any Stock Option held
by such optionee may thereafter be exercised to the extent it was exercisable at
the time of such Retirement, but may not be exercised after three months (or
such shorter period as the Committee shall specify at grant) from the date of
such termination of employment or the expiration of the stated term of the
option, whichever period is the shorter. In the event of termination of
employment by reason of Retirement, if an Incentive Stock Option is exercised
after the expiration of the exercise periods that apply for purposes of Section
422 of the Code, the option will thereafter be treated as a Non-Qualified Stock
Option.

(i) Other Termination. Unless otherwise determined by the Committee, if
an optionee's employment by the Company and any Subsidiary or Parent Corporation
terminates for any reason other than death, Disability or Retirement, the Stock
Option may be exercised to the extent it was exercisable at such termination for
the lesser of three months or the balance of the option's term, except that if
the optionee is terminated for Cause by the Company or any Subsidiary or Parent
Corporation, the Stock Option shall thereupon terminate immediately.

(j) Annual Limit on Incentive Stock Options. The aggregate Fair Market
Value (determined as of the time the Option is granted) of the Common Stock with
respect to which an Incentive Stock Option under this Plan or any other plan of
the Company and any Subsidiary or Parent Corporation is exercisable for the
first time by an optionee during any calendar year shall not exceed $100,000.

<PAGE>

SECTION 6. Stock Appreciation Rights.

(a) Grant and Exercise. Stock Appreciation Rights may be granted in
conjunction with all or part of any Stock Option granted under the Plan. In the
case of a Non-Qualified Stock Option, such rights may be granted either at or
after the time of the grant of such Option. In the case of an Incentive Stock
Option, such rights may be granted only at the time of the grant of the option.

A Stock Appreciation Right or applicable portion thereof granted with
respect to a given Stock Option shall terminate and no longer be exercisable
upon the termination or exercise of the related Stock Option, except that a
Stock Appreciation Right granted with respect to less than the full number of
shares covered by a related stock Option shall not be reduced until the exercise
or termination of the related Stock Option exceeds the number of shares not
covered by the Stock Appreciation Right.

A Stock Appreciation Right may be exercised by an optionee, in
accordance with paragraph (b) of this Section 6, by surrendering the applicable
portion of the related Stock Option. Upon such exercise and surrender, the
optionee shall be entitled to receive an amount determined in the manner
prescribed in paragraph (b) of this Section 6. Stock Options which have been so
surrendered, in whole or in part, shall no longer be exercisable to the extent
the related Stock Appreciation Rights have been exercised.

(b) Terms and Conditions. Stock Appreciation Rights shall be subject to
such terms and conditions, not inconsistent with the provisions of the Plan, as
shall be determined from time to time by the Committee, including the following:

(i) Stock Appreciation Rights shall be exercisable only at
such time or times and to the extent that the Stock Options to which
they relate shall be exercisable in accordance with the provisions of
Section 5 and this Section 6 of the Plan.

(ii) Upon the exercise of a Stock Appreciation Right, an
optionee shall be entitled to receive up to, but not more than, an
amount in cash or shares of Stock equal in value to the excess of the
Fair Market Value of one share of Stock over the option price per share
specified in the related option multiplied by the number of shares in
respect of which the Stock Appreciation Right shall have been
exercised, with the Committee having the right to determine the form of
payment; provided the Committee may not require the optionee to receive
more than 50% of the aggregate value of such Stock Appreciation Rights
in shares of Stock.

(iii) Stock Appreciation Rights shall be transferable only
when and to the extent that the underlying Stock Option would be
transferable under Section 5 of the Plan.

(iv) Upon the exercise of a Stock Appreciation Right, the
Stock Option or part thereof to which such Stock Appreciation Right is
related shall be deemed to have been

<PAGE>

exercised for the purpose of the limitation set forth in Sections 3 and
4 of the Plan on the total number of shares of Stock to be issued under
the Plan and the maximum number of shares to be awarded to any one
person in a fiscal year, but only to the extent of the number of shares
issued or issuable under the Stock Appreciation Right at the time of
exercise based on the value of the Stock Appreciation Right at such
time.

(v) A Stock Appreciation Right granted in connection with an
Incentive Stock Option may be exercised only if and when the market
price of the Stock subject to the Incentive Stock Option exceeds the
exercise price of such Option.

(vi) Each award shall be confirmed by, and subject to the
terms of, a Stock Appreciation Rights Agreement executed by the Company
and the participant.

SECTION 7. Restricted Stock.

(a) Administration. Shares of Restricted Stock may be issued either
alone or in addition to other awards granted under the Plan. The Committee shall
determine the officers and key employees of the Company and Subsidiaries to
whom, and the time or times at which, grants of Restricted Stock will be made,
the number of shares to be awarded, the time or times within which such awards
may be subject to forfeiture, and all other conditions of the awards. The
Committee may also condition the grant of Restricted Stock upon the attainment
of specified performance goals. The provisions of Restricted Stock awards need
not be the same with respect to each recipient.

(b) Awards and Certificates. The prospective recipient of an award of
shares of Restricted Stock shall not have any rights with respect to such award,
unless and until such recipient has executed an Agreement evidencing the award
and has delivered a fully executed copy thereof to the Company, and has
otherwise complied with the then applicable terms and conditions.

(i) Each participant shall be issued a stock certificate in
respect of shares of Restricted Stock awarded under the Plan. Such
certificate shall be registered in the name of the participant, and
shall bear an appropriate legend referring to the terms, conditions,
and restrictions applicable to such award, substantially in the
following form:

"The transferability of this certificate and the shares of
stock represented hereby are subject to the terms and
conditions (including forfeiture) of the CNS, Inc. 1994
Amended Stock Plan and an Agreement entered into between the
registered owner and CNS, Inc. Copies of such Plan and
Agreement are on file in the offices of CNS, Inc., P.O. Box
39802, Minneapolis, MN 55439."

(ii) The Committee shall require that the stock certificates
evidencing such shares be held in custody by the Company until the
restrictions thereon shall have lapsed, and that,

<PAGE>

as a condition of any Restricted Stock award, the participant shall
have delivered a stock power, endorsed in blank, relating to the Stock
covered by such award.

(c) Restrictions and Conditions. The shares of Restricted Stock awarded
pursuant to the Plan shall be subject to the following restrictions and
conditions:

(i) Subject to the provisions of this Plan and the award
Agreement, during a period set by the Committee commencing with the
date of such award (the "Restriction Period"), the participant shall
not be permitted to sell, transfer, pledge or assign shares of
Restricted Stock awarded under the Plan. In no event shall the
Restriction Period be less than one (1) year. Within these limits, the
Committee may provide for the lapse of such restrictions in
installments where deemed appropriate.

(ii) Except as provided in paragraph (c)(i) of this Section 7,
the participant shall have, with respect to the shares of Restricted
Stock, all of the rights of a shareholder of the Company, including the
right to vote the shares and the right to receive any cash dividends.
The Committee, in its sole discretion, may permit or require the
payment of cash dividends to be deferred and, if the Committee so
determines, reinvested in additional shares of Restricted Stock (to the
extent shares are available under Section 3 and subject to paragraph
(f) of Section 13). Certificates for shares of unrestricted Stock shall
be delivered to the grantee promptly after, and only after, the period
of forfeiture shall have expired without forfeiture in respect of such
shares of Restricted Stock.

(iii) Subject to the provisions of the award Agreement and
paragraph (c)(iv) of this Section 7, upon termination of employment for
any reason during the Restriction Period, all shares still subject to
restriction shall be forfeited by the participant.

(iv) In the event of special hardship circumstances of a
participant whose employment is terminated (other than for Cause),
including death, Disability or Retirement, or in the event of an
unforeseeable emergency of a participant still in service, the
Committee may, in its sole discretion, when it finds that a waiver
would be in the best interest of the Company, waive in whole or in part
any or all remaining restrictions with respect to such participant's
shares of Restricted Stock.

(v) Notwithstanding the foregoing, all restrictions with
respect to any participant's shares of Restricted Stock shall lapse on
the date determined by the Committee, but in no event more than sixty
(60) days prior to or subsequent to the occurrence of any of the
following events: (i) dissolution or liquidation of the Company other
than in conjunction with a bankruptcy of the Company or any similar
occurrence, (ii) any merger, consolidation, acquisition, separation,
reorganization, or similar occurrence, where the Company will not be
the surviving entity or (iii) the transfer of substantially all of the
assets of the Company or 20% or more of the outstanding Stock of the
Company.

<PAGE>

SECTION 8. Deferred Stock Awards.

(a) Administration. Deferred Stock may be awarded either alone or in
addition to other awards granted under the Plan. The Committee shall determine
the officers and key employees of the Company and Subsidiaries to whom and the
time or times at which Deferred Stock shall be awarded, the number of Shares of
Deferred Stock to be awarded to any participant or group of participants, the
duration of the period (the "Deferral Period") during which, and the conditions
under which, receipt of the Stock will be deferred, and the terms and conditions
of the award in addition to those contained in paragraph (b) of this Section 8.
The Committee may also condition the grant of Deferred Stock upon the attainment
of specified performance goals. The provisions of Deferred Stock awards need not
be the same with respect to each recipient.

(b) Terms and Conditions.

(i) Subject to the provisions of this Plan and the award
agreement, Deferred Stock awards may not be sold, assigned,
transferred, pledged or otherwise encumbered during the Deferral
Period. In no event shall the Deferral Period be less than one (1)
year. At the expiration of the Deferral Period (or Elective Deferral
Period, where applicable), share certificates shall be delivered to the
participant, or his legal representative, in a number equal to the
shares covered by the Deferred Stock award.

(ii) Amounts equal to any dividends declared during the
Deferral Period with respect to the number of shares covered by a
Deferred Stock award will be paid to the participant currently or
deferred and deemed to be reinvested in additional Deferred Stock or
otherwise reinvested, all as determined at the time of the award by the
Committee, in its sole discretion.

(iii) Subject to the provisions of the award Agreement and
paragraph (b)(iv) of this Section 8, upon termination of employment for
any reason during the Deferral Period for a given award, the Deferred
Stock in question shall be forfeited by the participant.

(iv) In the event of special hardship circumstances of a
participant whose employment is terminated (other than for Cause)
including death, Disability or Retirement, or in the event of an
unforeseeable emergency of a participant still in service, the
Committee may, in its sole discretion, when it finds that a waiver
would be in the best interest of the Company, waive in whole or in part
any or all of the remaining deferral limitations imposed hereunder with
respect to any or all of the participant's Deferred Stock.

(v) A participant may elect to further defer receipt of the
award for a specified period or until a specified event (the "Elective
Deferral Period"), subject in each case to the Committee's approval and
to such terms as are determined by the Committee, all in its sole
discretion. Subject to any exceptions adopted by the Committee, such
election must

<PAGE>

generally be made prior to completion of one half of the Deferral
Period for a Deferred Stock award (or for an installment of such an
award).

(vi) Each award shall be confirmed by, and subject to the
terms of, a Deferred Stock Agreement executed by the Company and the
participant.

SECTION 9. Other Awards.

The Committee may from time to time grant Stock, other Stock based and
non-Stock based awards under this Plan including without limitations those
awards pursuant to which shares of Stock are or in the future may be acquired,
awards denominated in Stock units, securities convertible into Stock, phantom
securities and dividend equivalents. The Committee shall determine the terms and
conditions of such Stock, Stock based and non-Stock based awards provided that
such awards shall not be inconsistent with the terms of this Plan.

SECTION 10. Transfer, Leave of Absence, etc.

For purposes of the Plan, the following events shall not be deemed a
termination of employment:

(a) a transfer of an employee from the Company to a Parent Corporation
or Subsidiary, or from a Parent Corporation or Subsidiary to the Company, or
from one Subsidiary to another;

(b) a leave of absence, approved in writing by the Committee, for
military service or sickness, or for any other purpose approved by the Company
if the period of such leave does not exceed ninety (90) days (or such longer
period as the Committee may approve, in its sole discretion); and

(c) a leave of absence in excess of ninety (90) days, approved in
writing by the Committee, but only if the employee's right to reemployment is
guaranteed either by a statute or by contract, and provided that, in the case of
any leave of absence, the employee returns to work within 30 days after the end
of such leave.

SECTION 11. Amendments and Termination.

The Board may amend, alter, or discontinue the Plan, but no amendment,
alteration, or discontinuation shall be made (i) which would impair the rights
of an optionee or participant under a Stock Option, Stock Appreciation Right,
Restricted Stock, Deferred Stock or other Stock-based award theretofore granted,
without the optionee's or participant's consent, or (ii) which without the
approval of the stockholders of the Company would cause the Plan to no longer
comply with Rule 16b-3 under the Securities Exchange Act of 1934, Section 422 of
the Code or any other regulatory requirements.

<PAGE>

The Committee may amend the terms of any award or option theretofore
granted, prospectively or retroactively to the extent such amendment is
consistent with the terms of this Plan, but no such amendment shall impair the
rights of any holder without his or her consent except to the extent authorized
under the Plan. The Committee may also substitute new Stock Options for
previously granted options, including previously granted options having higher
option prices.

SECTION 12. Unfunded Status of Plan.

The Plan is intended to constitute an "unfunded" plan for incentive and
deferred compensation. With respect to any payments not yet made to a
participant or optionee by the Company, nothing contained herein shall give any
such participant or optionee any rights that are greater than those of a general
creditor of the Company. In its sole discretion, the Committee may authorize the
creation of trusts or other arrangements to meet the obligations created under
the Plan to deliver Stock or payments in lieu of or with respect to awards
hereunder, provided, however, that the existence of such trusts or other
arrangements is consistent with the unfunded status of the Plan.

SECTION 13. General Provisions.

(a) All certificates for shares of Stock delivered under the Plan
pursuant to any Restricted Stock, Deferred Stock or other Stock-based awards
shall be subject to such stock-transfer orders and other restrictions as the
Committee may deem advisable under the rules, regulations, and other
requirements of the Securities and Exchange Commission, any stock exchange upon
which the Stock is then listed, and any applicable Federal or state securities
laws, and the Committee may cause a legend or legends to be put on any such
certificates to make appropriate reference to such restrictions.

(b) Subject to paragraph (d) below, recipients of Restricted Stock,
Deferred Stock and other Stock-based awards under the Plan (other than Stock
Options) are not required to make any payment or provide consideration other
than the rendering of services.

(c) Nothing contained in this Plan shall prevent the Board of Directors
from adopting other or additional compensation arrangements, subject to
stockholder approval if such approval is required; and such arrangements may be
either generally applicable or applicable only in specific cases. The adoption
of the Plan shall not confer upon any employee of the Company or any Subsidiary
any right to continued employment with the Company or a Subsidiary, as the case
may be, nor shall it interfere in any way with the right of the Company or a
Subsidiary to terminate the employment of any of its employees at any time.

(d) Each participant shall, no later than the date as of which any part
of the value of an award first becomes includible as compensation in the gross
income of the participant for Federal income tax purposes, pay to the Company,
or make arrangements satisfactory to the Committee regarding payment of, any
Federal, state, or local taxes of any kind required by law to be withheld with
respect to the award. The obligations of the Company under the Plan shall be
conditional on

<PAGE>

such payment or arrangements and the Company and Subsidiaries shall, to the
extent permitted by law, have the right to deduct any such taxes from any
payment of any kind otherwise due to the participant. With respect to any award
under the Plan, if the terms of such award so permit, a participant may elect by
written notice to the Company to satisfy part or all of the withholding tax
requirements associated with the award by (i) authorizing the Company to retain
from the number of shares of Stock that would otherwise be deliverable to the
participant, or (ii) delivering to the Company from shares of Stock already
owned by the participant, that number of shares having an aggregate Fair Market
Value equal to part or all of the tax payable by the participant under this
Section 13(d). Any such election shall be in accordance with, and subject to,
applicable tax and securities laws, regulations and rulings.

(e) At the time of grant, the Committee may provide in connection with
any grant made under this Plan that the shares of Stock received as a result of
such grant shall be subject to a repurchase right in favor of the Company
pursuant to which any participant shall be required to offer to the Company upon
termination of employment for any reason any shares that the participant
acquired under the Plan, with the price being the then Fair Market Value of the
Stock or, in the case of a termination for Cause, an amount equal to the cash
consideration paid for the Stock, subject to such other terms and conditions as
the Committee may specify at the time of grant. The Committee may, at the time
of grant of an award under the Plan, provide the Company with the right to
repurchase, or require forfeiture of, shares of Stock acquired pursuant to the
Plan by any participant who, at any time within one year after termination of
employment with the Company, directly or indirectly, competes with, or is
employed by a competitor of, the Company.

(f) The reinvestment of dividends in additional Restricted Stock (or in
Deferred Stock or other types of Plan awards) at the time of any dividend
payment shall only be permissible if the Committee (or the Company's chief
financial officer) certifies in writing that under Section 3 sufficient shares
are available for such reinvestment (taking into account then outstanding Stock
Options and other Plan awards).

SECTION 14. Effective Date of Plan.

The Plan is expressly made subject to the approval by the shareholders
of the Company. If the Plan is not so approved by the shareholders on or before
one year after this Plan's adoption by the Board of Directors, this Plan shall
not come into effect. The offering of the shares hereunder shall be also subject
to the effecting by the Company of any registration or qualification of the
shares under any federal or state law or the obtaining of the consent or
approval of any governmental regulatory body which the Company shall determine,
in its sole discretion, is necessary or desirable as a condition to or in
connection with, the offering or the issue or purchase of the shares covered
thereby. The Company shall make every reasonable effort to effect such
registration or qualification or to obtain such consent or approval.

- --------------------------
Adopted by the Board of Directors: June 17, 1994.
Ratified and Approved by the Shareholders: May 11, 1995.
Amended by the Board of Directors: February 10, 1997.
Amendment Ratified and Approved by the Shareholders: April 23, 1997.

(Certain information has been omitted from this exhibit and filed separately
with the SEC pursuant to a request for confidential treatment under Rule 24b-2)

LICENSE AGREEMENT

THIS AGREEMENT is made and effective as of May 9, 1997 by and between
CNS, Inc., a Delaware corporation ("Licensee"), Cigone Enterprises, Inc., a
Texas corporation ("Licensor"), and SmokeBusters of Texas, Inc. and Odor Pros,
Inc., each a Texas corporation (the "Affiliates").

RECITALS

WHEREAS, Licensor is now and has been engaged in developing certain
Products (as defined in Subsection 1.1) for use in removing the odor of smoke
from, among other things, hair and clothing;

WHEREAS, the Products embody inventions and designs owned exclusively
by Licensor and Licensor has available certain Know-how relating to the
manufacture of the Products;

WHEREAS, Licensor owns or controls, or may hereafter own or control,
certain Know-how, patents or patent applications relating to the Products;

WHEREAS, Licensor desires to license to Licensee and Licensee desires
to license from Licensor certain Know-how and patent applications of Licensor
relating to the manufacture and use of the Products for removing the odor of
smoke.

NOW, THEREFORE, in consideration of the premises, the mutual covenants
and agreements hereinafter set forth and other good consideration, the receipt
and sufficiency of which are hereby acknowledged, the parties agree as follows:

1. GENERAL DEFINITIONS. As used herein, the following terms shall be
defined in the manner set forth below:

1.1 Products. The term "Products" shall mean products containing
[confidential treatment requested] and water mixtures for removing the odor of
smoke and components or ingredients therefor and related thereto, all
improvements thereto, and any other products similar in function and purpose
developed by Licensor or any of its employees, consultants, agents or
representatives during the term of this Agreement using any Licensed Patents or
Know-how; provided, however, that for any such improvement or enhancement or
similar product developed by Licensor to be included within the license herein
granted, Licensee shall at its option make an election for such inclusion by
providing prior written notice of such election to Licensor within 30 days after
Licensee learns of such improvement, enhancement or similar product.

1.2 Know-how. The term "Know-how" shall mean any and all tangible and
intangible information, technology, documents and materials in the possession
and control of Licensor, necessary in order to enable Licensee to utilize fully
the rights granted by Licensor to Licensee hereunder and shall include, without
limiting the foregoing, the ideas, concepts, confidential information, trade
secrets and techniques, as well as all the materials, documents, manuals,

<PAGE>

schematics, blueprints, specifications, patterns, art work, bills of materials
and technical specifications and other information of Licensor relating to the
Products.

1.3 Licensed Patents. The term "Licensed Patents" shall mean the
following: (i) all future United States patent applications related to the
Products and any patents arising therefrom; (ii) the rights, patents and patent
applications, if any, in any country or jurisdiction in the world corresponding
to the United States patent applications; and (iii) any division, continuation,
continuation-in-part, divisional, re-examined, reissued or extended letters
patent, applications and petty patents, utility models, utility model
conversions, inventor's certificates relating to the inventions claimed in any
of the foregoing United States patents and patents pending and foreign patent
rights, which may be developed, acquired or controlled by Licensor during the
term of this Agreement and with respect to which Licensor shall have the right
to grant the license hereinafter provided.

1.4. Contract Year and Quarter. The term "Contract Year" shall mean
each period of twelve consecutive months commencing on January 1 of the year
designated in Subsection 4.3. The term "Contract Quarter" shall mean each period
of three consecutive months commencing January 1, March 1, July 1 and October 1.

1.5. Gross Revenues. The term "Gross Revenues" shall mean the gross
amounts collected by Licensee from any end-user, sublicensee, assignee or other
person or entity relating to or arising from the sale of Products after the
deduction of (i) any amounts repaid or credited by reason of rejections or
returns, and (ii) trade and quantity discounts actually allowed and taken.

1.6. Earned Royalty. The term "Earned Royalty" shall mean the royalty
payable to Licensor on Products.

2. GRANT OF LICENSES.

2.1 Patent and Know-how License. Except as otherwise set forth in
Section 2.5 below, Licensor hereby grants to Licensee an exclusive, worldwide,
transferable right and license to manufacture and have manufactured the Products
and an exclusive, worldwide, transferable license to use, sell and otherwise
practice the Products and all Know-how of Licensor and any invention disclosed
or claimed in any of the Licensed Patents for distribution as a product to
consumers, retailers, wholesalers or otherwise. Licensor and Affiliates agree
that they will (i) not manufacture or use Products except as set forth in
Section 2.5 below, (ii) not sell Products directly or indirectly to any third
party other than as set forth in Section 2.5 below, (iii) not enter into any
license or distribution arrangement with any person or entity other than
Licensee to manufacture or sell Products and (iv) enter into and take such steps
as are necessary to enforce agreements with purchasers of the Product which
prohibit such purchasers from selling or distributing Products.

2.2 Sublicenses and Assignments. Licensee may sublicense and/or assign
to any third party, including affiliates of Licensee, any and all rights granted
hereunder. In the event of an assignment, Licensee shall enter into a written
agreement with the assignee pursuant to which the assignee shall assume all of
the obligations of Licensee under this Agreement and this Agreement

<PAGE>

shall be binding upon and inure to the benefit of such assignee. In the event of
a sub-license, Licensee shall enter into a written agreement with sub-licensee
(i) with a term no greater than the term of this Agreement, (ii) with rights
granted to sub-licensee which are no greater than the terms of this Agreement,
and (iii) pursuant to which Licensee shall use reasonable business efforts to
impose upon sub-licensees similar obligations as Licensor has imposed upon
Licensee under this Agreement.

2.3 Patent Procurement and Costs. Licensee shall be responsible for and
pay all patent costs and expenses (including reasonable attorneys' fees) to be
incurred in obtaining, prosecuting, owning and maintaining any of the Licensed
Patents issued or to be issued under the law of any jurisdiction, including
filing, prosecution, working and maintenance costs and taxes. Notwithstanding
the above, Licensor shall direct and control the procurement of the Licensed
Patents and shall select patent counsel for such procurement (which counsel is
subject to the reasonable consent of Licensee), provided, however, that Licensee
shall have the right to terminate such patent counsel if Licensee has a
reasonable basis for not being satisfied with such counsel's efforts or results,
and in such event Licensor shall select a new patent counsel (which counsel is
subject to the reasonable consent of Licensee).

2.4 Exploitation. Except as set forth in Section 8, Licensee shall not
be under any obligation to use, exploit, develop or market any license under
this Agreement. Licensee shall be entitled to use its sole business judgment in
deciding the manner and extent, if any, of any exploitation of any licenses
granted hereunder and in deciding whether to use any other products, devices,
techniques or technology competing therewith in any field of use.

2.5 Reservation; Manufacture and Sale by Licensor. All rights not
explicitly granted to Licensee in this Agreement are expressly reserved to
Licensor. Notwithstanding any other provision in this Agreement, Licensor
specifically retains all rights in and to the Products, Licensed Patents, and
Know-how as such rights relate to Licensor's (i) manufacture and use (but not
sale) of the Products in its business and (ii) manufacture of Products for, and
the sale of the Products to, commercial end-users that agree not to sell the
Products, and Licensee acknowledges and agrees that Licensor may license the
Products to Affiliates for such limited purposes. Licensor and Affiliates shall
notify Licensee within five business days of any purchase orders of a third
party that exceed 40 gallons of concentrated Products in the aggregate in a
calendar month and, in such event, Licensee shall have the right to assume the
responsibility of manufacturing and distributing Products to such third party
purchaser on behalf of Licensee or Affiliates, provided that Licensee shall have
the right to terminate such sales upon a reasonable belief that such third party
purchaser is reselling the Products. The price for such Products to Licensor or
Affiliates for such third party purchasers shall be Licensee's actual and direct
cost to manufacture and ship such Products.

3. REPRESENTATIONS AND WARRANTIES.

3.1 Licensor and Affiliates each hereby warrant and represent to
Licensee as follows:

(a) Each of Licensor and Affiliates is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Texas.

<PAGE>

(b) This Agreement has been duly authorized, executed and
delivered by each of Licensor and Affiliates and constitutes a valid and binding
obligation of Licensor and Affiliates, enforceable in accordance with its terms,
except as rights to indemnification thereunder may be limited by applicable law
and except as the enforcement thereof may be limited by bankruptcy, insolvency,
reorganization, moratorium or other similar laws relating to or affecting
creditors' rights generally or by general equitable principles. The execution,
delivery and performance of this Agreement by Licensor and Affiliates and the
consummation of the transactions contemplated hereby do not and will not
conflict with or result in any material breach of any of the provisions of, or
constitute a material default under, or result in a material violation of, or
require any authorization, consent or approval, under the provisions of such
party's Articles of Incorporation or Bylaws or any other agreement or instrument
to which such party is bound or affected, or any law, statute, rule, regulation,
judgment order or decree to which such party is subject.

(c) Licensor owns all the rights of Sherrie Thomas and all
other employees, agents, consultants or representatives of Licensor with respect
to the Products, Licensed Patents and Know-how.

(d) To Licensor's knowledge, there is no reason that
enforceable patents will not issue in the United States or in any other
jurisdiction where corresponding rights are sought.

(e) To Licensor's knowledge, the Products, Licensed Patents
and Know-how do not infringe on any patent, copyright or other intellectual
property right of any third party.

(f) Licensor has not received notice of any claims, actions,
suits or proceedings pending or threatened effecting Licensor, the Licensed
Patents or Know-how, which, if adversely determined, would have a material
adverse effect upon Licensee's ability to manufacture, have manufactured, use or
sell the Products or otherwise practice the rights and technology licensed to
Licensee by Licensor under this Agreement and, to Licensor's knowledge, there is
no reasonable basis for anyone to bring such claims, actions, suits or
proceedings.

(g) Licensor has not received any claim from any third-party
proceedings relating to the Licensed Patents, Know-how, or the Products which
are based upon infringement of any patent or misappropriation or misuse of trade
secrets.

3.2 Licensee hereby warrants and represents to Licensor as follows:

(a) Licensee is a corporation duly organized, validly existing
and in good standing under the laws of the State of Delaware.

(b) This Agreement has been duly authorized, executed and
delivered by Licensee and constitutes a valid and binding obligation of
Licensee, enforceable in accordance with its terms, except as rights to
indemnification thereunder may be limited by applicable law and except as the
enforcement thereof may be limited by bankruptcy, insolvency, reorganization,
moratorium or other similar laws relating to or affecting creditors' rights
generally or by general equitable principles. The execution, delivery and
performance of this Agreement by Licensee and the consummation of the

<PAGE>

transactions contemplated hereby do not and will not conflict with or result in
any material breach of any of the provisions of, or constitute a material
default under, or result in a material violation of, or require any
authorization, consent or approval, under the provisions of Licensee's
Certificate of Incorporation or Bylaws.

4. CONSIDERATION AND REPORTS.

4.1 Royalties. Licensee agrees to pay to Licensor royalties as follows
based on the Gross Revenues from the sale of Products: (a) [Confidential
treatment requested] of Gross Revenues until royalties have been paid on an
aggregate total of [Confidential treatment requested] of Gross Revenues, then
(b) [Confidential treatment requested] of Gross Revenues until royalties have
been paid on an aggregate total of [Confidential treatment requested] of Gross
Revenues, and then (c) [Confidential treatment requested]% of all Gross Revenues
in excess of an aggregate total of [Confidential treatment requested]. The
royalty provided for in this Section 4.1 shall be reduced to [Confidential
treatment requested] of Gross Revenues, if and when (i) a third party through
patent proceedings negates the functional exclusionary utility of the Licensed
Patents issued in the United States taken as a whole or (ii) a third party is
marketing a competing product using the same key ingredient contained in the
Licensed Products and no patents are pending in the United States Patent and
Trademark Office with regard to the Products. In the event the royalty is
reduced pursuant to item (i) above and, as the result of a successful appeal or
otherwise, the functional exclusionary utility of the Licensed Patents is later
reinstated, then the royalty rate shall also be reinstated to its original
levels and Licensee shall pay Licensor an amount equal to the royalties which
Licensee would have been required to pay under the original royalty rates during
the period that the royalty was reduced, less the amount of royalties actually
paid during such period using the reduced royalty rate.

4.2 Quarterly Payments. All royalties due Licensor from Licensee
hereunder shall be payable on a Contract Quarterly basis. Within forty-five (45)
days after the end of each Contract Quarter during the term of this Agreement,
Licensee shall pay to Licensor the royalty due Licensor under Subsection 4.1
through the end of the preceding Contract Quarter and shall furnish Licensor
with a written statement setting forth the number of Products sold and the Gross
Revenues received during such Contract Quarter, and the resulting amount of the
royalty due Licensor under Subsection 4.1.

4.3 Minimum Royalties. To maintain its rights hereunder,
Licensee shall pay to Licensor minimum royalties as follows:

Minimum Royalty Payment Minimum Royalty Payment
Contract Year Per Contract Year Per Contract Quarter
------------- ----------------- --------------------
1998 [Confidential treatment requested]
1999 [Confidential treatment requested]
2000 [Confidential treatment requested]
2001 [Confidential treatment requested]

4.4 Minimum Royalty Payment. Licensee shall pay Licensor within
forty-five (45) days after the end of each Contract Quarter, an amount equal to
(i) the minimum royalties payable pursuant to the terms of Subsection 4.3 for
the Contract Quarter then ended, less (ii): (a) the aggregate amount of Earned
Royalties actually paid to Licensor pursuant to the terms of Subsections

<PAGE>

4.1 and 4.2 for the Contract Quarter then ended; (b) any patent costs, as
described in Subsection 2.4, paid by Licensee, including any patent cost carry
forwards, provided this deduction shall not reduce the payment to Licensor lower
than the minimum guaranteed payment in Section 4.3, but will be carried forward
and deducted in later periods; and (c) any Earned Royalties paid to Licensor
during the prior Contract Quarters in the current Contract Year that exceed the
amount of cumulative minimum royalties payable for those Contract Quarters.
Licensee's failure to pay any and all amounts payable under the preceding
sentence within thirty (30) days after receipt of written notice from Licensor
that such amounts have not been timely paid shall render the licenses granted
hereunder void and thereupon, Licensee shall have no further rights or interests
of any kind or nature with respect to the Products, Know-how, License or Patents
and Licensee shall take any and all action that Licensor may request to further
document the provisions hereof. In the event that any law, statute, regulation,
rule, guideline, ruling or decision prevents Licensee from marketing or offering
Products for sale, the minimum royalty payment will be suspended until such time
that Licensee is no longer prevented from marketing or offering Products for
sale.

4.5 Late Payment. Licensee shall have five (5) days to make any late
payments hereunder, without interest. Thereafter, Licensee shall pay a late
payment fee to Licensor calculated at a variable rate of 2% over the prime per
annum interest rate as set from time to time by Norwest Bank Minneapolis, N.A. ,
Minneapolis, Minnesota (the "Interest Rate"), on any and all amounts that are at
any time overdue and payable to Licensor under this Agreement, such interest
being calculated on each such overdue amount from the date when such amount
became due to the date of actual payment thereof. Such late payment fee shall be
in addition to and not in lieu of any and all other rights or remedies that
Licensor may have under this Agreement or law relating to a default by Licensee
under this Agreement.

4.6 Records. During the term of this Agreement and for three (3) years
after termination of this Agreement, Licensee shall at all times maintain
accurate and up-to-date records containing complete data from which amounts due
to Licensor under this Agreement may be readily calculated. Further, Licensee
shall preserve and permit examination of such records by Licensor's
representatives at reasonable intervals and under reasonable conditions during
the term of this Agreement and for three (3) years thereafter and, upon request,
shall supply to Licensor's representatives all information useful in making a
proper audit and verification of Licensee's performance of its obligations under
this Agreement.

4.7 Underpayment. If Licensor determines by audit and inspection of
Licensee's books and records that Licensee has failed to pay all royalties due
under Subsection 4.1, Licensee shall pay Licensor 105% of such additional
royalties as may be due. If the amount of underpayment exceeds 5% of the
royalties due under Subsection 4.1, then Licensor shall, in addition to any
other remedies available to it, recover from Licensee the reasonable costs
incurred in making any such audit and inspection pursuant to Section 4.6 hereof
which revealed such shortfall.

4.8 Buy-Out of License Rights. At any time on or after January 1, 2002,
Licensee may purchase any and all rights to the Products, Know-how and Licensed
Patents, as such rights are set forth in Section 2.1 above, by giving Licensor
written notification of its election to exercise this buy-out option and by
making the following payments (collectively referred to herein as the "Buy-Out

<PAGE>

Payments") to Licensor: (i) an amount equal to three (3) times the total Earned
Royalty paid or payable with respect to the most recent four (4) consecutive
Contract Quarters (the "Evaluation Period"), and (ii) quarterly payments in the
amount of [confidential treatment requested] per Contract Quarter ending on the
earlier of the twelfth Contract Quarter after the buy-out option is exercised or
the Contract Quarter ending on December 31, 2006; provided that Licensee shall
not be entitled to make such election and consummate such purchase unless a
competing product is being offered and Gross Revenues during the Evaluation
Period do not exceed Gross Revenues from the four (4) consecutive Contract
Quarters preceding the Evaluation Period.

5. INDEMNIFICATION.

5.1 Indemnification by Licensor. Licensor shall indemnify and hold
Licensee harmless from and against any and all claims, damages, costs (including
reasonable attorneys' fees), judgments and liabilities of any kind or nature
arising out of the breach by Licensor of any of its warranties, representations
and covenants under this Agreement or by any misuse by Licensor of the patent
process or fraud by Licensor on the patent office or notice by Licensor before
the date hereof of a claim by any party of a prior or superseding right to
practice the art of and commercialize the Products.

5.2 Indemnification by Licensee. Licensee shall indemnify and hold
Licensor harmless from and against any and all claims, damages, costs (including
reasonable attorneys' fees), judgments and liabilities of any kind or nature:
(a) arising out of the breach by Licensee of any of its covenants under this
Agreement; or (b) arising out of any actual or alleged defect in a Product.

6. PROTECTION AGAINST INFRINGEMENT. In the event that Licensee becomes
aware of activity on the part of any third party which may constitute
infringement of the Licensed Patents, or any other intellectual property rights
with respect to which Licensee is granted a license hereunder, Licensee shall
give Licensor written notice thereof. Upon reasonable request by Licensor,
Licensee shall, at its sole expense, initiate and thereafter diligently maintain
reasonable efforts to prevent and abate such infringement, including the
initiation of an appropriate civil action for infringement and the taking of
such other action as may be necessary or appropriate, to enforce the Licensed
Patents or other intellectual property rights with respect to which Licensee is
granted a license hereunder. In such event, (i) Licensor will permit the use of
its name in, and as a party to, all such suits and execute all pleadings,
documents and other papers necessary or appropriate in conjunction therewith and
(ii) Licensee shall receive the full benefits of any action it takes pursuant to
this subsection, including retaining all sums recovered in any such suit or in
settlement thereof after paying Licensor the Earned Royalties which shall be
calculated from the amount of Gross Revenues, if any, asserted by Licensee to
support any award of compensatory damages (as opposed to punitive or any other
damages). Licensor may, at its option and its cost and expense, participate in
meetings with Licensee and/or its counsel and receive all pleadings, documents
and other related papers useful for the purpose of keeping Licensor informed of
the status of any proceedings commenced by Licensee pursuant to this Section 6.

<PAGE>

7. TERM AND TERMINATION.

7.1 Term. This Agreement shall commence on the effective date hereof
and shall expire, unless earlier terminated pursuant to Sections 4.8, 7.2 or 7.3
of this Agreement, upon the expiration of the last of the Licensed Patents to
expire or, at the sole discretion of Licensee, ten (10) years from the date
hereof if no patent has issued. If a pending patent issues after ten (10) years
from the date hereof and after the expiration of the Agreement, the Agreement
shall be reinstated in full and shall expire, unless terminated pursuant to the
terms of this Agreement, upon the expiration of the last of the Licensed
Patents.

7.2 Termination by Licensor. If Licensee defaults in any of its
obligations under this Agreement, Licensor shall have the right to terminate
this Agreement by giving thirty (30) days' written notice of termination
specifying the reason for termination, provided that such notice will be of no
effect and termination will not occur if the specified default is cured prior to
the expiration of said thirty (30) day notice period.

7.3 Termination by Licensee. (a) This Agreement may be terminated by
Licensee at any time at will, with or without cause, by the giving of at least
thirty (30) days' written notice to Licensor by Licensee in which event such
license shall terminate upon the effective date stated in any such notice. In
the event of the termination of any such license, neither Licensor nor Licensee
shall have any further obligation to the other party hereunder except as
expressly provided in Subsection 7.4 below.

(b) Upon the termination of any license granted under this
Agreement, Licensee may, after the effective date of such termination, sell any
of its (i) completed Products, (ii) Products then in the process of manufacture
and (iii) Products with respect to which manufacture has been committed at the
time of termination by reason of either (x) any contracts for the purchase of
materials to be used in the manufacture of such Products or (y) any contract for
the sale of such Products. All such sales and uses shall be subject to the
royalty provisions of Section 4 of this Agreement as though the termination of
this Agreement had not occurred.

(c) Except as expressly provided in Subsection 7.3(b), after
termination of this Agreement, Licensee may not use develop, market or sell the
Products, Know-how, or Licensed Patents in any way or manner that would violate
any rights of Licensor and Licensee shall take any and all steps reasonably
requested by Licensor to fully document the complete vesting of all rights
licensed hereunder to Licensee by Licensor upon any such termination.

7.4 Continued Obligations. Termination shall not relieve or release
either party from its obligations to make any payment which may be owing to the
other under the terms of this Agreement or from any other liability which either
party may have to the other arising out of the terms of this Agreement.
Additionally, notwithstanding anything contained herein to the contrary,
Sections 3, 4 (including Subsection 4.8 to the extent then exercised) and 5
shall survive termination of this Agreement and remain in full force and effect;
provided, that Licensor and Licensee hereby acknowledge that they may not bring
claims against one another based upon the representations and

<PAGE>

warranties contained in Section 3, except to the extent such representations and
warranties are not accurate as of the date hereof.

8. LICENSEE'S UNDERTAKINGS.

8.1 Licensing Fee and Payment. On the date hereof, Licensee will pay to
Licensor the sum of $20,000 as a license fee.

8.2 Manufacturing. Licensee will develop systems, or have systems
developed for, and will begin the manufacture of salable Products by October 1,
1997, provided no law, statute, regulation, rule, ruling, guideline, order or
decision prevent Licensee from marking or offering Products for sale.

8.3 Marketing. No later than January 1, 1998, Licensee will prepare
promotional materials and sample packages of Products for promotional
distribution. Licensee will also attend relevant trade shows and train its
direct sales force and independent sales representative groups under contract to
begin selling the Products.

8.4 Marking. Licensee shall apply the patent notices to the Products
and Product advertising and packaging that are reasonably required by Licensor.

8.5 Confidentiality. Licensee shall maintain the confidentiality of
Licensor's confidential information, both during and after the term of this
Agreement. After this Agreement is terminated, Licensee shall not use any of
Licensor's confidential information for any purpose that is not specifically
provided for in Section 7.3(b) of this Agreement.

9. MISCELLANEOUS.

9.1 Force majeure. Neither party shall be responsible for any delay or
failure in the performance of any obligation hereunder due to strikes, lockouts,
fires, floods, acts of God, embargoes, wars, riots, or act or order of any
government or governmental agency; provided, however, nothing set forth in this
Subsection 9.1 shall be construed to relieve Licensee of the requirement that it
pay minimum royalties pursuant to Subsections 4.3 and 4.4 hereof.

9.2 Waiver. The waiver or failure of either party to enforce the terms
of this Agreement in one instance shall not constitute a waiver of said party's
right under this Agreement with respect to other violations.

9.3 Remedies. The election by either party of any particular right or
remedy shall not be deemed to exclude any other right or remedy and all rights
and remedies of either party shall be cumulative. The parties agree that, in
addition to any other relief afforded under the terms of this Agreement or by
law, each party shall have the right to enforce this Agreement by injunctive or
mandatory relief to be issued against the other party, it being understood that
both damages and specific performance shall be proper modes of relief and are
not to be considered as alternative remedies.

<PAGE>

9.4 Notices. All notices and replies thereto required hereunder shall
be in writing, signed by the party giving notice, placed in an envelope and
either delivered by hand or sent by facsimile or registered mail, postage
prepaid, return receipt requested, and properly addressed to the other party.
Notices sent by mail shall be deemed received on the date of receipt indicated
by the receipt verification provided by the United States Postal Service.
Notices sent by facsimile shall be deemed received on the date indicated on the
sender's confirmation report. Notice shall be given, mailed or sent to the other
party at the following addresses or at such other address as may be given by
proper notice:

If to Licensor
or Affiliates: Cigone Enterprises, Inc.
[confidential treatment requested]
Attn: Sherrie Thomas

With a copy to: Kuperman, Orr, Mouer & Albers
100 Congress Avenue
Suite 1400
Austin, TX 78701
Attn: Vince Mouer
Fax No.: 512-322-8143

If to Licensee: CNS, Inc.
4400 West 78th Street
Minneapolis, MN 55435
Attn: Daniel E. Cohen, M.D.
Fax No.: 612-820-6697

With a copy to: Lindquist & Vennum P.L.L.P.
4200 IDS Center
80 South 8th Street
Minneapolis, MN 55402-2205
Attn: Patrick Delaney
Fax No.: 612-317-3207

Either party hereto may designate any other address for notices given
hereunder by written notice to the other party given at least ten (10) days
prior to the effective date of such change.

9.5 Entire Agreement. Agreement represents the entire agreement between
the parties with respect to the subject matter hereof; there are no oral
promises, representations or warranties. No modification of this Agreement or
waiver of any of its terms shall be binding upon the parties unless said
modification or waiver is in writing, signed by both parties, and states that it
is an amendment to this Agreement.

<PAGE>

9.6 Parties in Interest. This Agreement shall inure to the benefit of,
be binding upon, and be enforceable against the parties hereto, their respective
successors and assigns.

9.7 Governing Law. This Agreement shall be governed by, construed and
enforced under the internal laws (and not the laws of conflicts) of the State of
Minnesota.

9.8 Severability. If any portion of this Agreement is held invalid by
the final judgment of any court of competent jurisdiction, such portion shall be
deemed revised or "blue lined" so that it is enforceable to the fullest extent
possible under applicable law and the remaining provisions shall remain in full
force and effect as if such invalid provision had not been included herein.

IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.

CNS, INC.

By: Daniel E. Cohen, M.D.

Its: President

CIGONE ENTERPRISES

By: Sherrie Thomas

Its: President

SMOKEBUSTERS OF TEXAS, INC.

By: Sherrie Thomas

Its: President

ODOR PROS, INC.

By: Sherrie Thomas

Its: President

Exhibit 11

CNS, INC.

Computation of Net Income per Share of Common Stock

<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
NET INCOME
Income from continuing operations $ 8,770,316 $15,522,484 $13,310,505
Income from discontinued operations 0 0 765,989
----------- ----------- -----------

Net income $ 8,770,316 $15,522,484 $14,076,494
=========== =========== ===========

BASIC NET INCOME PER SHARE
Weighted average number of common
shares outstanding 19,119,000 18,704,000 17,221,000
=========== =========== ===========

From continuing operations $ .46 $ .83 $ .77
From discontinued operations .00 .00 .05
----------- ----------- -----------

Basic net income per share $ .46 $ .83 $ .82
=========== =========== ===========

DILUTED NET INCOME PER SHARE
Weiighted average number of common and assumed
conversion shares outstanding:
Weighted average number of common
shares outstanding 19,119,000 18,704,000 17,221,000
Incentive stock options 422,000 636,000 680,000
Non qualified stock options 260,000 392,000 403,000
Warrants 1,000 75,000 72,000
----------- ----------- -----------

19,802,000 19,807,000 18,376,000
=========== =========== ===========

From continuing operations $ .44 $ .78 $ .72
From discontinued operations .00 .00 .04
----------- ----------- -----------

Diluted net income per share $ .44 $ .78 $ .76
=========== =========== ===========
</TABLE>

FINANCIAL HIGHLIGHTS

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Results of Operations(1)(2):
Net sales:
Domestic net sales ................... $ 60,601,757 $ 60,098,235 $ 47,196,414 $ 2,798,174 $ 93,352
International net sales .............. 6,355,377 25,768,290 1,435,441 0 0
-----------------------------------------------------------------------------
Total net sales .................... 66,957,134 85,866,525 48,631,855 2,798,174 93,352
-----------------------------------------------------------------------------
Gross profit ........................... 45,664,139 52,519,647 31,077,442 1,008,629 44,840
Operating income (loss) ................ 9,644,195 21,742,602 12,398,086 (2,757,636) (395,554)
Income (loss) from continuing operations
before income taxes .................. 12,620,316 24,022,484 12,969,505 (2,558,101) (298,753)
Income (loss) from continuing operations 8,770,316 15,522,484 13,310,505 (2,558,101) (298,753)
Net income (loss) ...................... 8,770,316 15,522,484 14,076,494 (2,867,415) (1,430,773)
Diluted net income (loss) per share:
From continuing operations ........... $ .44 $ .78 $ .72 $ (.16) $ (.02)
From discontinued operations ......... .00 .00 .04 (.02) (.09)
-----------------------------------------------------------------------------
Diluted net income (loss) per share $ .44 $ .78 $ .76 $ (.18) $ (.11)
==============================================================================
Weighted average number of common and
assumed conversion shares outstanding 19,802,000 19,807,000 18,376,000 15,755,000 13,145,000

DECEMBER 31,
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------

Financial Position(1):
Working capital ........................ $ 76,919,076 $ 78,402,795 $ 25,855,456 $ 10,790,457 $ 3,716,040
Total assets ........................... 88,494,973 89,409,067 32,340,535 11,612,871 3,871,506
Stockholders' equity ................... 80,644,501 79,774,907 26,885,342 11,206,535 3,871,506

</TABLE>

(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.

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of operations
should be read in conjunction with the Company's audited financial statements
and notes thereto appearing elsewhere in this Annual Report. In the opinion of
the Company's management, the quarterly unaudited information set forth below
has been prepared on the same basis as the audited financial information, and
includes all adjustments (consisting only of normal, recurring adjustments)
necessary to present this information fairly when read in conjunction with the
Company's financial statements and notes thereto.

OVERVIEW
The Company was founded in 1982. From 1987 until 1995, the Company designed,
manufactured and marketed computer-based diagnostic devices for sleep disorders.
Beginning in 1995, the Company focused on the Breathe Right(R) nasal strip and
divested itself of the assets related to its sleep disorders business. Unless
otherwise noted, the following discussion of financial condition and results of
operations relate only to continuing operations of the Company. The Company's
revenues are derived primarily from the manufacture and sale of the Breathe
Right nasal strip. Revenue from sales is recognized when earned, at the time
products are shipped.
The Company obtained the license to manufacture and sell the Breathe Right
nasal strip in 1992 and received FDA clearance in October 1993 to market the
Breathe Right nasal strip as a product that improves nasal breathing. In
September 1994, the Company launched its consumer marketing program which was
enhanced by broad media coverage of the use of Breathe Right nasal strips by
professional football players. At the same time, a number of radio and
television personalities provided unsolicited endorsements of the product on
national radio and television.
During 1995, the Company continued its marketing efforts and also focused
on expanding its distribution network both domestically and internationally.
In the first quarter of 1995, a rapid increase in domestic demand for the
product resulted in the Company being unable to secure delivery of sufficient
raw materials to avoid large back orders and out of stock situations at the
retail level. The Company eliminated the back orders and began building
inventory by the end of the second quarter of 1995.
In August 1995, the Company signed an exclusive international distribution
agreement with 3M to market Breathe Right nasal strips outside the U.S. and
Canada. At the end of 1995, Breathe Right nasal strips were available in most
domestic drug stores, mass merchants and warehouse clubs and a majority of
grocery stores. In November 1995, the Company received FDA clearance to market
the Breathe Right nasal strip for the reduction or elimination of snoring and
began marketing programs emphasizing the snoring benefits of the product.
In February 1996, the Company received FDA clearance to market the Breathe
Right nasal strip for the temporary relief of nasal congestion and thereafter
launched a media program to increase consumer awareness of the benefits of the
product for this application. In June 1996, the Company received FDA clearance
to market the Breathe Right nasal strip for the temporary relief of breathing
difficulties due to a deviated nasal septum. In July 1996, U.S. Utility Patents
were issued covering the basic invention of the Breathe Right nasal strip and
additional elements incorporated in the product. By the end of 1996, the
Company's international distributor, 3M, had introduced the Breathe Right nasal
strip in more than 30 foreign countries.
During 1997, the Company increased the level of domestic marketing
expenditures, primarily through national television advertising, in order to
increase the level of new trial and repeat usage of Breathe Right nasal strips.
While usage of the product increased, the overall results of the increased level
of marketing, especially in the first quarter of 1997, did not meet
expectations. In order to improve the effectiveness of advertising and promotion
programs, the Company hired a new advertising agency on April 1, 1997. The new
advertising campaign developed for the fourth quarter of 1997 focused on the
benefits of improved sleep resulting from better nasal breathing, with the
slogan "Breathe Right. Sleep Tight.(TM)"
As discussed in more detail below, the Company's international sales
decreased during 1997. The Company believes that a higher level of advertising
and promotion is needed in international markets and is working with 3M to amend
the distribution agreement to permit the Company to take a more active role in
advertising and promoting the product in certain countries in the future.
In January 1997, the Company was sued for patent infringement. The Company
believes it has good and sufficient defenses to the claim of patent
infringement. Cross motions for summary judgment with respect to the lawsuit are
pending. In February 1998, the company that brought the patent infringement suit
against the Company was issued a patent entitled "Transparent Nasal Dilator" and
commenced another patent infringement lawsuit against the Company. The Company
intends to defend this action vigorously.
Also, during 1997 the Company became aware of a foreign reference to a
nasal dilator, not commercially available, that will result in narrower
protection in the future from the patents licensed for Breathe Right nasal
strips.

<PAGE>

OPERATING RESULTS
The tables below set forth certain selected financial information of the Company
and the percentage of net sales represented by certain items included in the
Company's statements of income for the periods indicated.

<TABLE>
<CAPTION>
THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1997 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Domestic net sales ............. $16,909 $12,623 $12,352 $18,718 $60,602
International net sales ........ 2,486 970 291 2,608 6,355
---------------------------------------------------
Net sales .................... 19,395 13,593 12,643 21,326 66,957
Cost of goods sold ............. 6,245 4,456 3,897 6,695 21,293
---------------------------------------------------
Gross profit ................. 13,150 9,137 8,746 14,631 45,664
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 11,124 4,900 4,582 11,033 31,639
General and administrative ... 762 812 933 768 3,275
Product development .......... 202 289 246 369 1,106
---------------------------------------------------
Total operating expenses .... 12,088 6,001 5,761 12,170 36,020
---------------------------------------------------
Operating income ............ 1,062 3,136 2,985 2,461 9,644
Interest income ................ 710 777 773 716 2,976
---------------------------------------------------
Income from continuing
operations before income taxes $ 1,772 $ 3,913 $ 3,758 $ 3,177 $12,620
===================================================

THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1996 1996 1996 1996 1996
- ---------------------------------------------------------------------------------------
(In thousands)
Domestic net sales ............. $17,986 $12,611 $11,582 $17,919 $60,098
International net sales ........ 2,835 8,508 7,793 6,632 25,768
---------------------------------------------------
Net sales .................... 20,821 21,119 19,375 24,551 85,866
Cost of goods sold ............. 7,652 9,147 8,000 8,548 33,347
---------------------------------------------------
Gross profit ................. 13,169 11,972 11,375 16,003 52,520
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 7,430 6,917 4,862 7,589 26,798
General and administrative ... 738 645 760 727 2,870
Product development .......... 157 340 336 275 1,109
---------------------------------------------------
Total operating expenses .... 8,325 7,902 5,958 8,591 30,777
---------------------------------------------------
Operating income ............ 4,844 4,070 5,417 7,412 21,743
Interest income ................ 155 685 696 743 2,279
---------------------------------------------------
Income from continuing
operations before income taxes $ 4,999 $ 4,755 $ 6,113 $ 8,155 $24,022
===================================================

THREE MONTHS ENDED (UNAUDITED) YEAR
- --------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1995 1995 1995 1995 1995
- --------------------------------------------------------------------------------------
(In thousands)
Domestic net sales ............. $7,151 $18,540 $10,180 $11,324 $47,196
International net sales ........ 308 278 108 742 1,436
--------------------------------------------------
Net sales .................... 7,459 18,818 10,288 12,066 48,632
Cost of goods sold ............. 2,850 7,072 3,513 4,119 17,555
--------------------------------------------------
Gross profit ................. 4,609 11,746 6,775 7,947 31,077
--------------------------------------------------
Operating expenses:
Marketing and selling ........ 2,140 3,788 4,836 5,931 16,695
General and administrative ... 254 377 639 657 1,927
Product development .......... 46 7 3 0 57
--------------------------------------------------
Total operating expenses .... 2,440 4,172 5,478 6,588 18,679
--------------------------------------------------
Operating income ............ 2,169 7,574 1,297 1,359 12,398
Interest income ................ 84 124 214 149 572
--------------------------------------------------
Income from continuing
operations before income taxes $2,253 $ 7,698 $ 1,511 $ 1,508 $12,970
==================================================

THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1997 1997 1997 1997 1997
- ---------------------------------------------------------------------------------------

Net sales ...................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ............. 32.2 32.8 30.8 31.4 31.8
---------------------------------------------------
Gross profit ................. 67.8 67.2 69.2 68.6 68.2
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 57.4 36.0 36.2 51.8 47.3
General and administrative ... 3.9 6.0 7.4 3.6 4.9
Product development .......... 1.0 2.1 2.0 1.7 1.6
---------------------------------------------------
Total operating expenses .... 62.3 44.1 45.6 57.1 53.8
---------------------------------------------------
Operating income ............ 5.5 23.1 23.6 11.5 14.4
Interest income ................ 3.6 5.7 6.1 3.4 4.4
---------------------------------------------------
Income from continuing
operations before income taxes 9.1% 28.8% 29.7% 14.9% 18.8%
===================================================

THREE MONTHS ENDED (UNAUDITED) YEAR
- ---------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1996 1996 1996 1996 1996
- ---------------------------------------------------------------------------------------

Net sales ...................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ............. 36.7 43.3 41.3 34.8 38.8
---------------------------------------------------
Gross profit ................. 63.3 56.7 58.7 65.2 61.2
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 35.7 32.8 25.1 30.9 31.2
General and administrative ... 3.5 3.0 3.9 3.0 3.3
Product development .......... .8 1.6 1.7 1.1 1.3
---------------------------------------------------
Total operating expenses .... 40.0 37.4 30.7 35.0 35.8
---------------------------------------------------
Operating income ............ 23.3 19.3 28.0 30.2 25.3
Interest income ................ .7 3.2 3.6 3.0 2.7
---------------------------------------------------
Income from continuing
operations before income taxes 24.0% 22.5% 31.6% 33.2% 28.0%
===================================================

THREE MONTHS ENDED (UNAUDITED) YEAR
- ----------------------------------------------------------------------------- ENDED
MAR 31, JUN 30, SEP 30, DEC 31, DEC 31,
1995 1995 1995 1995 1995
- ---------------------------------------------------------------------------------------

Net sales ...................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold ............. 38.2 37.6 34.2 34.1 36.1
---------------------------------------------------
Gross profit ................. 61.8 62.4 65.8 65.9 63.9
---------------------------------------------------
Operating expenses:
Marketing and selling ........ 28.7 20.1 47.0 49.2 34.3
General and administrative ... 3.4 2.0 6.2 5.4 4.0
Product development .......... .6 .1 .0 .0 .1
---------------------------------------------------
Total operating expenses .... 32.7 22.2 53.2 54.6 38.4
---------------------------------------------------
Operating income ............ 29.1 40.2 12.6 11.3 25.5
Interest income ................ 1.1 .7 2.1 1.2 1.2
---------------------------------------------------
Income from continuing
operations before income taxes 30.2% 40.9% 14.7% 12.5% 26.7%
===================================================
</TABLE>

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

1997 COMPARED TO 1996
NET SALES. Net sales were $67.0 million for 1997 compared to $85.9 million for
1996. Breathe Right nasal strip sales decreased in 1997 as a result of a
decrease in international sales. The Company has experienced in the past, and
expects that it will continue to experience in the future, quarterly
fluctuations in both domestic and international sales and earnings. These
fluctuations are due in part to seasonality of sales as described below, as well
as increases and decreases in purchases by distributors and retailers in
anticipation of future demand by consumers.
For the year 1997, domestic sales increased to $60.6 million from $60.1
million for 1996. While our domestic sales dollars were relatively flat in 1997
compared to 1996, both retail sell-through and our strip sales, measured in
units, increased by approximately ten percent. This is primarily due to a higher
percentage of sales in 30 and 24 count boxes compared to ten count boxes.
International sales decreased to $6.4 million for 1997 from $25.8 million
for 1996. International sales in 1996 represented primarily initial inventory
purchases by 3M, the Company's international distributor, and initial stocking
of inventory at international retail outlets in certain countries. The lower
level of international sales in 1997 reflects continued high inventory levels at
3M. As a result, the quarterly international sales patterns for 1997 are not
comparable to the quarters of 1996 and may not be comparable to the quarters of
1998. The Company believes a higher level of advertising and promotion is needed
in international markets and is working with 3M to amend the distribution
agreement to permit the Company to take a more active role in advertising and
promoting the product in certain countries in the future.
GROSS PROFIT. Gross profit was $45.7 million for 1997 compared to $52.5
million for 1996. Gross profit as a percentage of net sales was 68.2% for 1997
compared to 61.2% for 1996. The higher gross profit as a percentage of net sales
in 1997 was due to the lower level of international sales. The Company obtains
lower gross profit margins on international sales because the Company sells
product to 3M at a price lower than its sales price in domestic markets. In
connection with these international sales, 3M is responsible for substantially
all of the operating expenses and a portion of the packaging costs. Domestic
gross profit as a percentage of domestic net sales for 1997 was approximately
1.5 percentage points higher than 1996, due to a combination of lower
manufacturing costs obtained from sub contractors, an increase in the selling
price of certain products and changes in the mix of products sold. The Company
is continuing efforts to reduce the manufacturing costs of the product and
improve gross profit margins on sales.
MARKETING AND SELLING EXPENSES. Marketing and selling expenses were $31.6
million for 1997 compared to $26.8 million for 1996. This increase resulted
primarily from heavier levels of advertising primarily associated with domestic
national television advertising. Marketing and selling expenses as a percentage
of net sales increased to 47.3% in 1997 from 31.2% in 1996 as a result of the
increase in expenses and lower level of international sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $3.3 million for 1997 compared to $2.9 million for 1996. This increase
resulted primarily from expenses associated with patent litigation. General and
administrative expenses as a percentage of net sales increased to 4.9% in 1997
from 3.3% in 1996 primarily as a result of the lower level of international
sales.
PRODUCT DEVELOPMENT EXPENSES. Product development expenses were $1.1
million for 1997 and 1996. Product development expenses as a percentage of net
sales increased to 1.6% in 1997 from 1.3% in 1996 primarily as a result of the
lower level of international sales.
INTEREST INCOME. Interest income was $3.0 million for 1997 compared to $2.3
million for 1996. This increase resulted primarily from investment of net
proceeds from the public offering of common stock completed in the second
quarter of 1996.
INCOME TAX EXPENSE. Income tax expense for 1997 was $3.9 million or 30.5%
of income before income taxes compared to $8.5 million or 35.4% for 1996. The
lower effective income tax rate was due primarily to the higher level of tax
exempt interest income as a percentage of income before income taxes.

1996 COMPARED TO 1995
NET SALES. Net sales increased to $85.9 million for 1996 from $48.6 million for
1995. Breathe Right nasal strip sales increased in 1996 in part as a result of
increased consumer advertising, particularly national television and radio, and
the commencement of international sales.
Unlike domestic sales in the first nine months of 1995, which reflected an
increase in inventory levels at existing and new retail outlets, domestic sales
during 1996 approximated off the shelf movement at retail due to increased
consumer demand for the product. As a result, the quarterly domestic sales
patterns for the first three quarters of 1996 are not directly comparable to the
first three quarters of 1995. During the fourth quarter of 1996, domestic retail

<PAGE>

sell-through of Breathe Right nasal strips was estimated to be approximately 50
percent higher than the fourth quarter of 1995. For the year 1996, domestic
retail sell-through approximately doubled from the 1995 level.
International sales increased to $25.8 million for 1996 from $1.4 million
for 1995. International sales in 1996 represented primarily initial inventory
purchases by 3M, the Company's international distributor, and initial stocking
of inventory at international retail outlets in certain countries.
GROSS PROFIT. Gross profit was $52.5 million for 1996 compared to $31.1
million for 1995. Gross profit as a percentage of net sales was 61.2% for 1996
compared to 63.9% for 1995. The lower gross profit in 1996 was due to the higher
level of international sales. Domestic gross profit as a percentage of domestic
net sales for 1996 was approximately 4 percentage points higher than 1995,
primarily due to lower manufacturing costs resulting from the Company bringing a
portion of the packaging operation in-house and increased production levels.
MARKETING AND SELLING EXPENSES. Marketing and selling expenses were $26.8
million for 1996 compared to $16.7 million for 1995. This increase resulted
primarily from expenses associated with national television and radio
advertising. Marketing and selling expenses as a percentage of net sales
decreased to 31.2% in 1996 from 34.3% in 1995 as a result of the higher level of
sales.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $2.9 million for 1996 compared to $1.9 million for 1995. This increase
resulted from the additional personnel and systems required to support growth of
the Breathe Right nasal strip business. General and administrative expenses as a
percentage of net sales decreased to 3.3% in 1996 from 4.0% in 1995 as a result
of the higher level of sales.
PRODUCT DEVELOPMENT EXPENSES. Product development expenses were $1.1
million for 1996 compared to $57,000 for 1995. This increase resulted from
expenses associated with the development of potential new products and
enhancements to the Breathe Right nasal strip. Product development expenses as a
percentage of net sales increased to 1.3% in 1996 from .1% in 1995 primarily as
a result of increased expenditures.
INTEREST INCOME. Interest income was $2.3 million for 1996 compared to
$572,000 for 1995. This increase resulted primarily from investment of net
proceeds from the public offering of common stock completed in the second
quarter of 1996.
INCOME TAX BENEFIT (EXPENSE). Income tax expense for 1996 was $8.5 million
or 35.4% of income before income taxes. The income tax benefit for 1995 of
$341,000 resulted from the recognition of the benefit of net operating losses
and credit carry forwards from prior years by the elimination of the valuation
allowance on deferred tax assets due to the Company's expected future taxable
income. There were no net operating loss carry forwards available for 1996 or
future years.

SEASONALITY
The Company believes that approximately 50% of Breathe Right nasal strip users
currently use the product for the temporary relief of nasal congestion and
congestion-related snoring. Sales of nasal congestion remedies are higher during
the fall and winter seasons because of increased use during the cold season. For
this reason the Company's domestic net sales were relatively higher in the first
and fourth quarters.

LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company had cash, cash equivalents and marketable
securities of $59.7 million and working capital of $76.9 million.
OPERATING ACTIVITIES. The Company generated cash from operations of
approximately $8.0 million for 1997 compared to $16.4 million for 1996. The
reduced cash flow was primarily due to a decrease in net income.
INVESTING ACTIVITIES. The Company purchased, net of sales and maturities,
marketable securities of $9.1 million in 1997 compared to $42.4 million in 1996
which included net proceeds from the 1996 public offering of common stock.
Marketable securities purchased consisted of cash equivalents, commercial paper,
corporate bonds, U.S. Government obligations and municipal bonds.
The Company purchased $1.2 million of property and equipment in 1997,
primarily associated with the upgrade of management information systems,
compared to $465,000 in 1996. Capitalized product rights were $1.6 million in
1997 compared to $141,000 in 1996. The Company currently expects to spend up to
an aggregate of $7.0 million on capital expenditures in 1998 and 1999 in order
to among other things supplement its in-house manufacturing capability and to
complete the expansion and upgrade of management information systems. The actual
amount of the expenditures as well as the timing of the expenditures may be
subject to change.
The Company has reviewed the ability of its computer systems to process
transactions relating to the year 2000 and beyond and believes that all
significant systems are compliant.
FINANCING ACTIVITIES. In 1997, the Company's Board of Directors authorized
and the Company purchased one million shares of its common stock for

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

$8.3 million. These treasury shares are to be used to meet the Company's
obligations under its employee stock ownership plan and stock option plans, and
for possible future acquisitions. The Company received $362,000 in 1997 from the
exercise of stock options.
In April 1996, the Company completed a public offering of 1,725,000 shares
of common stock. Of these shares, 1,525,000 shares were sold by the Company and
200,000 shares by selling shareholders. Net proceeds to the Company were $35.5
million. The Company also received $686,000 in 1996 from the exercise of stock
options.
In June 1995, the Company sold all the assets of its sleep disorder
diagnostic products business. Proceeds from the sale included $5.0 million cash
and a note receivable of $596,000 that was collected later in 1995. The Company
also received $1.1 million in 1995 from the exercise of stock options and
warrants.
The Company believes that its existing funds and funds generated from
operations will be sufficient to support its planned operations for the
foreseeable future, including capital expenditures noted above and possible
future acquisitions of products that would complement existing operations.

RECENT ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement No.
128, Earnings Per Share. The Company adopted the provisions of this Statement in
1997. The FASB also issued Statement No. 130, Reporting Comprehensive Income and
Statement No. 131, Disclosures about Segments of an Enterprise and Related
Information. The Company intends to adopt these standards in 1998 by making the
required disclosures. Therefore, the adoption of these standards is not expected
to have an effect on the Company's financial position or results of operations.

FORWARD LOOKING STATEMENTS
This Annual Report contains forward-looking statements under the Private
Securities Litigation Reform Act of 1995 that are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
presently anticipated or projected. Such forward-looking statements can be
identified by the use of terminology such as "may," "will," "expect," "plan,"
"intend," "anticipate," "estimate," or "continue" or comparable terminology.
Factors that could cause actual results to differ from the results discussed in
the forward-looking statements include, but are not limited to: (i) the
Company's revenue and profitability is currently reliant on sales of a single
product; (ii) the Company's success will depend, to a large extent, on the
enforceability and comprehensiveness of the patents on the Breathe Right nasal
strip technology, and the Company has been sued for patent infringement (see
Item 3, Legal Proceedings in the Company's Form 10-K for the year ended December
31, 1997); (iii) the markets in which the Company competes are highly
competitive; and (iv) the risk factors included in the Company's Prospectus
dated March 29, 1996.

<PAGE>

STATEMENTS OF INCOME CNS, Inc.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales ................................................. $ 66,957,134 $ 85,866,525 $ 48,631,855
Cost of goods sold ........................................ 21,292,995 33,346,878 17,554,413
----------------------------------------------
Gross profit ............................................ 45,664,139 52,519,647 31,077,442
----------------------------------------------
Operating expenses:
Marketing and selling ................................... 31,638,518 26,798,820 16,695,428
General and administrative .............................. 3,275,636 2,869,163 1,926,988
Product development ..................................... 1,105,790 1,109,062 56,940
----------------------------------------------
Total operating expenses ............................... 36,019,944 30,777,045 18,679,356
----------------------------------------------
Operating income ....................................... 9,644,195 21,742,602 12,398,086
Interest income ........................................... 2,976,121 2,279,882 571,419
----------------------------------------------
Income from continuing operations before income taxes .. 12,620,316 24,022,484 12,969,505
Income tax benefit (expense) .............................. (3,850,000) (8,500,000) 341,000
----------------------------------------------
Income from continuing operations ...................... 8,770,316 15,522,484 13,310,505
Loss from operations of discontinued sleep division
(less applicable income tax benefit of $259,000 in 1995) 0 0 (459,901)
Gain on sale of sleep division (less applicable
income taxes of $690,000 in 1995) ....................... 0 0 1,225,890
----------------------------------------------
Net income ............................................. $ 8,770,316 $ 15,522,484 $ 14,076,494
==============================================

Basic net income per share:
From continuing operations .............................. $ .46 $ .83 $ .77
From discontinued operations ............................ .00 .00 .05
----------------------------------------------
Basic net income per share ............................. $ .46 $ .83 $ .82
----------------------------------------------
Weighted average number of common shares outstanding ...... 19,119,000 18,704,000 17,221,000
==============================================
Diluted net income per share:
From continuing operations .............................. $ .44 $ .78 $ .72
From discontinued operations ............................ .00 .00 .04
----------------------------------------------
Diluted net income per share ........................... $ .44 $ .78 $ .76
==============================================
Weighted average number of common and
assumed conversion shares outstanding ................... 19,802,000 19,807,000 18,376,000
==============================================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.

<PAGE>

BALANCE SHEETS CNS, Inc.

<TABLE>
<CAPTION>
December 31,
1997 1996
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 229,647 $12,109,150
Marketable securities ...................................... 59,458,236 50,339,193
Accounts receivable, net of allowance for doubtful accounts
of $210,000 in 1997 and 1996 .............................. 11,392,001 14,665,731
Inventories ................................................ 8,624,663 8,314,826
Prepaid expenses and other current assets .................. 3,295,001 1,647,055
Deferred income taxes ...................................... 1,770,000 961,000
----------------------------
Total current assets .................................... 84,769,548 88,036,955
Property and equipment, net .................................. 1,863,007 839,415
Product rights, net .......................................... 1,502,520 192,633
Certificate of deposit, restricted ........................... 359,898 340,064
----------------------------
$ 88,494,973 $89,409,067
============================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ........................................... $ 3,130,660 $ 5,134,683
Accrued expenses ........................................... 3,561,279 3,179,944
Accrued income taxes ....................................... 1,158,533 1,319,533
----------------------------
Total current liabilities ................................ 7,850,472 9,634,160
----------------------------
Stockholders' equity:
Preferred stock -- authorized 8,483,589 shares;
none issued or outstanding ................................ 0 0
Common stock-- $.01 par value; authorized 50,000,000 shares;
issued and outstanding 19,294,570 shares in 1997
and 19,145,445 shares in 1996 ............................. 192,946 191,454
Additional paid-in capital ................................. 63,495,718 63,177,939
Treasury shares-- at cost; 961,511 shares in 1997 .......... (8,219,993) 0
Retained earnings .......................................... 25,175,830 16,405,514
----------------------------
Total stockholders' equity .............................. 80,644,501 79,774,907
Commitments (notes 9 and 10)
----------------------------
$ 88,494,973 $89,409,067
============================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.

<PAGE>

STATEMENTS OF STOCKHOLDERS' EQUITY CNS, Inc.

YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
COMMON STOCK TREASURY SHARES
-------------------- ADDITIONAL ------------------------ TOTAL
NUMBER PAR PAID-IN NUMBER RETAINED STOCKHOLDERS'
OF SHARES VALUE CAPITAL OF SHARES COST EARNINGS EQUITY
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 ....... 17,041,656 $170,416 $ 24,229,583 0 $ 0 $(13,193,464) $ 11,206,535
Stock issued in connection
with Employee Stock
Purchase Plan ................. 5,365 54 22,377 0 0 0 22,431
Stock options exercised ......... 129,870 1,299 379,034 0 0 0 380,333
Tax benefit from stock
options exercised ............. 0 0 485,000 0 0 0 485,000
Warrants exercised, less issuance
costs of $35,000 .............. 210,961 2,109 712,440 0 0 0 714,549
Net income for the year ......... 0 0 0 0 0 14,076,494 14,076,494
--------------------------------------------------------------------------------------------
Balance at December 31, 1995 ....... 17,387,852 173,878 25,828,434 0 0 883,030 26,885,342
Proceeds from public stock
offering less issuance
costs of $2,469,000 ........... 1,525,000 15,250 35,449,926 0 0 0 35,465,176
Stock issued in connection
with Employee Stock
Purchase Plan ................. 893 9 11,048 0 0 0 11,057
Stock options exercised ......... 231,700 2,317 683,531 0 0 0 685,848
Tax benefit from stock
options exercised ............. 0 0 1,205,000 0 0 0 1,205,000
Net income for the year ......... 0 0 0 0 0 15,522,484 15,522,484
--------------------------------------------------------------------------------------------
Balance at December 31, 1996 ....... 19,145,445 191,454 63,177,939 0 0 16,405,514 79,774,907
Stock issued in connection
with Employee Stock
Purchase Plan ................. 927 10 7,180 (1,489) 8,464 0 15,654
Stock options exercised ......... 77,300 773 241,308 (37,000) 50,062 0 292,143
Tax benefit from stock
options exercised ............. 0 0 70,000 0 0 0 70,000
Warrants exercised .............. 70,898 709 (709) 0 0 0 0
Treasury shares purchased ....... 0 0 0 1,000,000 (8,278,519) 0 (8,278,519)
Net income for the year ......... 0 0 0 0 0 8,770,316 8,770,316
--------------------------------------------------------------------------------------------
Balance at December 31, 1997 ....... 19,294,570 $192,946 $ 63,495,718 961,511 $(8,219,993) $ 25,175,830 $ 80,644,501
============================================================================================

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.

<PAGE>

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net income .......................................................... $ 8,770,316 $ 15,522,484 $ 14,076,494
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Net gain on sale of assets of discontinued operations ............. 0 0 (1,915,890)
Depreciation and amortization ..................................... 460,044 259,822 187,428
Deferred income taxes ............................................. (809,000) (58,000) (418,000)
Changes in operating assets and liabilities:
Accounts receivable .............................................. 3,273,730 (6,834,938) (6,894,514)
Inventories ...................................................... (309,837) 2,786,083 (9,975,900)
Prepaid expenses and other current assets ........................ (1,647,946) (649,381) (752,055)
Net assets of discontinued operations ............................ 0 0 (814,201)
Accounts payable and accrued expenses ............................ (1,783,688) 5,383,967 5,048,857
-----------------------------------------------
Net cash provided by (used in) operating activities ............. 7,953,619 16,410,037 (1,457,781)
-----------------------------------------------
Investing activities:
Purchases of marketable securities .................................. (99,045,360) (177,630,971) (42,709,438)
Sales and maturities of marketable securities ....................... 89,926,317 135,200,938 39,768,835
Payments for purchases of property and equipment .................... (1,239,918) (464,675) (383,810)
Payments for product rights ......................................... (1,553,605) (141,309) (73,426)
Purchase of certificate of deposit, restricted ...................... (19,834) (20,064) (320,000)
Net proceeds from promissory note ................................... 0 0 595,611
-----------------------------------------------
Net cash used in investing activities ........................... (11,932,400) (43,056,081) (3,122,228)
-----------------------------------------------
Financing activities:
Net proceeds from sale of discontinued operations ................... 0 0 5,000,000
Net proceeds from public stock offering ............................. 0 35,465,176 0
Proceeds from the issuance of common stock
under Employee Stock Purchase Plan ................................. 15,654 11,057 22,431
Proceeds from the exercise of stock options ......................... 362,143 685,848 380,333
Proceeds from exercise of common stock warrants ..................... 0 0 714,549
Purchase of treasury shares ......................................... (8,278,519) 0 0
-----------------------------------------------
Net cash (used in) provided by financing activities ............. (7,900,722) 36,162,081 6,117,313
-----------------------------------------------
Net (decrease) increase in cash and cash equivalents ............ (11,879,503) 9,516,037 1,537,304
Cash and cash equivalents:
Beginning of year ................................................... 12,109,150 2,593,113 1,055,809
-----------------------------------------------
End of year ......................................................... $ 229,647 $ 12,109,150 $ 2,593,113
-----------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest .............................. $ 0 $ 0 $ 12,500
Cash paid during the year for income taxes .......................... 4,750,000 6,541,467 0
===============================================
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.

<PAGE>

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1997, 1996 AND 1995

NOTE 1 SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
BUSINESS CNS, Inc. ("the Company"), designs, manufactures and markets consumer
products, primarily the Breathe Right(R) nasal strip. The Breathe Right nasal
strip is a nonprescription, single use, disposable device that can reduce or
eliminate snoring by improving nasal breathing and temporarily relieving nasal
congestion. The Breathe Right nasal strip is sold over-the-counter in retail
outlets, including drug, grocery and mass merchant stores. The Company has an
international distribution agreement with 3M Company to market Breathe Right
nasal strips outside the U.S. and Canada.

REVENUE RECOGNITION Revenue from sales is recognized at the time products are
shipped.

ACCOUNTING ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

FAIR VALUE OF FINANCIAL INSTRUMENTS All financial instruments are carried at
amounts that approximate fair value.

CASH EQUIVALENTS Cash equivalents consist primarily of money market funds.

MARKETABLE SECURITIES The Company classifies its marketable debt securities as
available-for-sale and records these securities at fair market value. Net
realized and unrealized gains and losses are determined on the specific
identification cost basis. Any unrealized gains and losses are reflected as a
separate component of stockholders' equity. A decline in the market value of any
available-for-sale security below cost that is deemed other than temporary,
results in a charge to operations resulting in the establishment of a new cost
basis for the security.

INVENTORIES Inventories are valued at the lower of cost (determined on a
first-in, first-out basis) or market.

PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Equipment is
depreciated using the straight-line method over five years. Leasehold
improvements are amortized over the lesser of the estimated useful life of the
improvement or the term of the lease.

PRODUCT RIGHTS Product rights, consisting of patents, trademarks and other
product rights, are stated at cost and are amortized over three to seven years
using the straight-line method.

STOCK BASED COMPENSATION The Company follows the disclosure requirements for
stock based compensation plans and, accordingly, no compensation expense has
been recognized.

FOREIGN SALES Foreign sales are made in U.S. dollars only. There are no currency
conversions.

ADVERTISING The Company expenses the production costs of advertising the first
time the advertising runs.

INCOME TAXES Deferred tax assets and liabilities and the resultant provision for
income taxes are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse.

NET INCOME Per Share In 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings
Per Share, which simplifies the standards for computing earnings per share. SFAS
No. 128 replaces the presentation of primary earnings per share with a
presentation of basic earnings per share, which excludes dilution. The Company
adopted SFAS No. 128 during 1997 and replaced previously reported primary net
income per share with basic net income per share.
Basic net income per share has been computed based upon the weighted
average number of common shares outstanding during the year. Diluted net income
per share has been computed based upon the weighted average number of common and
assumed conversion shares outstanding during the year.

NEW ACCOUNTING STANDARDS In 1997, the FASB issued SFAS No. 130, Reporting
Comprehensive Income and No. 131, Disclosures about Segments of an Enterprise
and Related Information. The Company intends to adopt these standards in 1998 by
making the required disclosures. Therefore, the adoption of these standards is
not expected to have an effect on the Company's financial position or results of
operations.

NOTE 2 SALE OF DIVISION
On June 1, 1995 the Company completed the sale of all the assets of its sleep
disorder diagnostic products division. Net sale proceeds of $5,000,000 cash and
a note receivable of $596,000 resulted in a gain on the sale of discontinued
operations of $1,916,000. The net loss of this operation is shown on the
statement of income as the loss from discontinued operations.

NOTE 3 MARKETABLE SECURITIES
Marketable securities, including estimated fair value based on quoted market
prices or valuation models, are summarized as follows (in thousands):

<PAGE>

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31,
1997 1996
- ------------------------------------------------------------------------
COST FAIR VALUE COST FAIR VALUE
- ------------------------------------------------------------------------
Cash equivalents .......... $ 805 $ 805 $ 497 $ 497
Commercial paper .......... 0 0 2,486 2,486
Corporate bonds ........... 3,772 3,772 6,045 6,045
U.S. Government obligations 3,994 3,994 1,998 1,998
Municipal bonds ........... 50,887 50,887 39,313 39,313
- ------------------------------------------------------------------------
Total marketable securities $59,458 $59,458 $50,339 $50,339
========================================================================

Maturities of marketable securities at December 31, 1997 are as follows (in
thousands):

COST FAIR VALUE
- -------------------------------------------------------------
Due within one year .................. $22,566 $22,566
Due after one year through three years 36,892 36,892
- -------------------------------------------------------------
Total marketable securities .......... $59,458 $59,458
=============================================================

There were no realized gains or losses during 1997, 1996 or 1995.

NOTE 4 ADVERTISING
At December 31, 1997 and 1996 $1,337,000 and $212,000, respectively, of
advertising costs were reported as assets. Advertising expense was $21,160,000
in 1997, $16,215,000 in 1996, and $11,839,000 in 1995.

NOTE 5 DETAILS OF SELECTED BALANCE SHEET ACCOUNTS
Details of selected balance sheet accounts are as follows (in thousands):

1997 1996 1995
- ---------------------------------------------------------------
Allowance for doubtful accounts:
Balance beginning of year .......... $210 $201 $ 55
Plus provision for doubtful accounts 5 123 154
Less charge offs ................... 5 114 8
- ---------------------------------------------------------------
Balance end of year ............... $210 $210 $201
===============================================================

DECEMBER 31,
1997 1996
- ---------------------------------------------------------------------
Inventories:
Finished goods ............................... $6,475 $6,254
Work in process .............................. 468 462
Raw materials and component parts ............ 1,682 1,599
- ---------------------------------------------------------------------
Total inventories ........................... $8,625 $8,315
- ---------------------------------------------------------------------
Property and equipment:
Production equipment ......................... $ 928 $ 789
Office equipment and information systems 1,477 376
- ---------------------------------------------------------------------
2,405 1,165
Less accumulated depreciation ................ 542 326
- ---------------------------------------------------------------------
Property and equipment, net ................. $1,863 $ 839
- ---------------------------------------------------------------------
Product rights:
Product rights ............................... $1,920 $ 366
Less accumulated amortization ................ 417 173
- ---------------------------------------------------------------------
Product rights, net ......................... $1,503 $ 193
- ---------------------------------------------------------------------
Accrued expenses:
Promotions and allowances .................... $1,926 $1,305
Royalties and commissions .................... 1,214 1,284
Salaries, incentives and paid time off ....... 273 392
Other ........................................ 148 199
- ---------------------------------------------------------------------
Total accrued expenses ...................... $3,561 $3,180
=====================================================================

NOTE 6 STOCKHOLDERS' EQUITY
Stock Options The Company's stock option plans allow for the grant of options to
officers, directors, and employees to purchase up to 2,950,000 shares of common
stock at exercise prices not less than 100% of fair market value on the dates of
grant. The term of the options may not exceed ten years and vest in increments
over 1 to 5 years from the grant date. The plans allow for the grant of shares
of restricted common stock. No shares of restricted common stock have been
granted under these plans as of December 31, 1997.

Stock option activity under these plans is summarized as follows:

WEIGHTED-AVERAGE SHARES
EXERCISE PRICE SHARES AVAILABLE
PER SHARE OUTSTANDING FOR GRANT
- ------------------------------------------------------------------------
Balance at December 31, 1994 $ 2.50 1,047,600 832,622
Granted .................. 5.80 698,000 (698,000)
Exercised ................ 2.93 (129,870) 0
Canceled ................. 4.88 (107,430) 107,430
- ------------------------------------------------------------------------
Balance at December 31, 1995 3.85 1,508,300 242,052
Granted .................. 17.61 175,000 (175,000)
Exercised ................ 2.96 (231,700) 0
- ------------------------------------------------------------------------
Balance at December 31, 1996 5.65 1,451,600 67,052
Granted .................. 7.13 110,000 (110,000)
Exercised ................ 2.56 (114,300) 0
Canceled ................. 16.79 (90,000) 90,000
Unused 1987 expired ...... -- 0 (31,702)
Amend 1994 Plan .......... -- 0 750,000
- ------------------------------------------------------------------------
Balance at December 31, 1997 $ 5.29 1,357,300 765,350
========================================================================

At December 31, 1997, the range of exercise prices and weighted-average
remaining contractual life of outstanding options was $1.31 - $18.13 and 6.8
years, respectively. At December 31, 1997, 1996 and 1995, currently exercisable
options aggregated 958,100, 775,700 and 653,000 shares of common stock,
respectively and the weighted-average exercise price of those options was $4.00,
$3.87 and $3.10, respectively.
The per share weighted-average fair value of stock options granted during
1997, 1996 and 1995 is estimated as $2.38, $11.00 and $3.48, respectively on the
date of grant using the Black-Scholes option pricing model with the following
assumptions: volatility of 65%; risk-free interest rate of 6.25% in 1997 and
5.4% in 1996 and 1995; and an expected life of 6 years.
The Company applies APB No. 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for its plans. Accordingly, no
compensation expense has been recognized for its stock-based compensation plans.
Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No. 123, Accounting for Stock-Based
Compensation, the Company's net income and diluted earnings per share would have
been reduced by approximately $350,000, or $.02 per share in 1997, $900,000, or
$.05 per share in 1996 and $1.5 million, or $.08 per share in 1995.
Pro forma net income reflects only options granted in 1997, 1996 and 1995.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the

<PAGE>

pro forma net income amounts presented because compensation cost is reflected
over the options' vesting period and compensation cost for options granted prior
to January 1, 1995 is not considered.

EMPLOYEE STOCK PURCHASE Plan The Employee Stock Purchase Plan allows eligible
employees to purchase shares of the Company's common stock through payroll
deductions. The purchase price is the lower of 85% of the fair market value of
the stock on the first or last day of each six-month period during which an
employee participated in the plan. The Company has reserved 200,000 shares under
the plan of which 138,802 shares have been purchased by employees
as of December 31, 1997.

WARRANTS During 1997 and 1995 warrants to purchase a total of 100,000 shares at
$2.75 were exercised. The warrants had been issued in connection with an
agreement to license a product to be marketed as the Breathe Right device.
During 1995 warrants to purchase 200,000 shares at $3.75 were exercised. The
warrants had been issued to the underwriter of the Company's 1994 public stock
offering.
In connection with an agreement to license a potential product, the
licenser was issued a warrant during 1997 to purchase 25,000 shares of the
Company's common stock exercisable at a price of $8.00 per share which expires
November 2002.

PREFERRED STOCK At December 31, 1997, the Company is authorized to issue
1,000,000 shares of Series A Junior Participating Preferred Stock upon a
triggering event under the Company's stockholders' rights plan and 7,483,589
shares of undesignated preferred.

NOTE 7 INCOME TAXES
Income tax expense (benefit), from continuing operations, for the three years
ended December 31, 1997, excluding tax on discontinued operations, is as follows
(in thousands):

CURRENT DEFERRED TOTAL
- ---------------------------------------------------------------
1997:
Federal ..................... $4,154 $(728) $ 3,426
State ....................... 505 (81) 424
- ---------------------------------------------------------------
Income tax expense (benefit) $4,659 $(809) $ 3,850
- ---------------------------------------------------------------
1996:
Federal ..................... $8,164 $ (52) $ 8,112
State ....................... 394 (6) 388
- ---------------------------------------------------------------
Income tax expense (benefit) $8,558 $ (58) $ 8,500
- ---------------------------------------------------------------
1995:
Federal ..................... $ 532 $(853) $ (321)
State ....................... 30 (50) (20)
- ---------------------------------------------------------------
Income tax expense (benefit) $ 562 $(903) $ (341)
===============================================================

Income tax expense (benefit) attributable to income from continuing operations
differed from the amounts computed by applying the U.S. federal income tax rate
of 35% as a result of the following (in thousands):

<TABLE>
<CAPTION>
1997 1996 1995
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Computed tax expense ........................... $ 4,417 $ 8,408 $ 4,539
State taxes, net of federal benefit ............ 331 452 389
Tax exempt interest ............................ (765) (185) 0
Benefit of foreign sales corporation ........... (127) (417) 0
Change in deferred tax asset valuation allowance 0 0 (5,439)
Other .......................................... (6) 242 170
- -------------------------------------------------------------------------------------
Actual tax expense (benefit) ................. $ 3,850 $ 8,500 $ (341)
=====================================================================================

</TABLE>

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities for 1997 and
1996 are presented below (in thousands):

DECEMBER 31,
1997 1996
- -------------------------------------------------------
Deferred tax assets:
Inventory items ............. $ 363 $ 294
Accounts receivable allowance 78 78
Product rights .............. 55 55
Accrued expenses ............ 1,328 574
Tax credits ................. 0 24
- -------------------------------------------------------
1,824 1,025
Deferred tax liabilities:
Property and equipment ...... (54) (64)
- -------------------------------------------------------
Net deferred tax assets .... $ 1,770 $ 961
=======================================================

NOTE 8 SALES
The Company had two significant customers, including 3M Company, who accounted
for approximately 28% of total sales in 1997 and 42% of total sales in 1996, and
had one significant customer who accounted for approximately 13% of total sales
in 1995. Accounts receivable from these customers as of December 31, 1997 and
1996 were $5,082,000 and $6,762,000, respectively. Foreign sales by geographic
area are as follows (in thousands):

1997 1996 1995
- ------------------------------------------------------
Europe ............... $4,319 $12,617 $ 162
Asia ................. 730 10,616 370
Other ................ 1,306 2,535 904
- ------------------------------------------------------
Total foreign sales $6,355 $25,768 $1,436
======================================================

NOTE 9 LICENSE AGREEMENT
The Company has an agreement to exclusively license the Breathe Right nasal
strip. Royalties due under this agreement are 3% of net sales. To maintain the
Company's license, it must make minimum royalty payments of $450,000 each year
until patents for the product expire. Royalty expense was $1,995,000 in 1997,
$2,647,000 in 1996 and $1,458,000 in 1995.

NOTE 10 OPERATING LEASES
The Company leases equipment and office space under noncancelable operating
leases which expire over the next three years. Future minimum lease payments due
in accordance with these leases as of December 31, 1997 are as follows (in
thousands):

YEAR ENDING DECEMBER 31, AMOUNT
- -------------------------------------------------
1998 ................................ $ 455
1999 ................................ 455
2000 ................................ 412
- -------------------------------------------------
Future minimum lease payments $1,322
=================================================

<PAGE>

NOTES TO FINANCIAL STATEMENTS

Total rental expense for operating leases was $471,000 in 1997, $473,000 in
1996, and $377,000 in 1995.
The Company's office space lease requires a $320,000 letter of credit to
remain with the lessor. The letter of credit is secured by a $360,000
certificate of deposit.

NOTE 11 EARNINGS PER SHARE
A reconciliation of basic and diluted average common shares outstanding are as
follows (in thousands):

1997 1996 1995
- ---------------------------------------------------------------------------
Average common shares outstanding .......... 19,119 18,704 17,221
Assumed conversion of stock options ........ 682 1,028 1,083
Assumed conversion of warrants ............. 1 75 72
- ---------------------------------------------------------------------------
Average common and assumed conversion shares 19,802 19,807 18,376
===========================================================================

Options to purchase 108,000 shares of common stock at $11.375 to $18.125 per
share were outstanding during 1997 but were not included in the computation of
diluted earnings per share because the exercise prices of the options were
greater than the average market price of the common shares. The options expire
in 2005 and 2006.

INDEPENDENT AUDITORS' REPORT

THE BOARD OF DIRECTORS AND STOCKHOLDERS
CNS, INC.:

We have audited the accompanying balance sheets of CNS, Inc. as of December 31,
1997 and 1996 and the related statements of income, stockholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CNS, Inc. as of December 31,
1997 and 1996 and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 1997 in conformity with
generally accepted accounting principles.

/s/ KPMG PEAT MARWICK LLP

Minneapolis, Minnesota
January 21, 1998

COMMON STOCK INFORMATION

PRICE RANGE The Common Stock of the Company is traded under the symbol "CNXS"on
the Nasdaq National Market. The following table sets forth the high and low last
sale prices of the Company's stock for the periods indicated.

1997 HIGH LOW
- -----------------------------------------------------------
First Quarter $16 3/4 $ 8
Second Quarter 12 3/8 8 1/8
Third Quarter 9 1/2 6 5/8
Fourth Quarter 8 3/4 5 11/16

1996 HIGH LOW
- -----------------------------------------------------------
First Quarter $25 7/8 $14 5/8
Second Quarter 25 1/8 19
Third Quarter 25 3/8 15 3/8
Fourth Quarter 20 1/2 13 1/2

SHAREHOLDERS As of March 3, 1998, there were approximately 850 owners of record
of the Common Stock and an estimated 17,000 beneficial holders whose shares were
registered in the names of nominees.

DIVIDEND POLICY The Company has never paid any cash dividends on its Common
Stock. The Company currently intends to retain any earnings for use in its
operations and does not anticipate paying any cash dividends in the foreseeable
future.

EXHIBIT 21.1

SUBSIDIARIES OF THE COMPANY

Jurisdiction
Name of Subsidiary of Organization
- ------------------ ---------------
CNS FSC, Inc. Barbados

Exhibit 23.1

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 21, 1998, relating to the balance sheets of CNS, Inc. as of
December 31, 1997 and 1996, and the related statements of income, stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1997, which report is incorporated by reference in the December 31,
1997 annual report on Form 10-K of CNS, Inc.

KPMG Peat Marwick LLP

Minneapolis, Minnesota
March 27, 1998

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 229,647
<SECURITIES> 59,458,236
<RECEIVABLES> 11,392,001
<ALLOWANCES> 0
<INVENTORY> 8,624,663
<CURRENT-ASSETS> 84,769,548
<PP&E> 1,863,007
<DEPRECIATION> 0
<TOTAL-ASSETS> 88,494,973
<CURRENT-LIABILITIES> 7,850,472
<BONDS> 0
0
0
<COMMON> 192,946
<OTHER-SE> 80,451,555
<TOTAL-LIABILITY-AND-EQUITY> 88,494,973
<SALES> 66,957,134
<TOTAL-REVENUES> 66,957,134
<CGS> 21,292,995
<TOTAL-COSTS> 36,019,944
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 12,620,316
<INCOME-TAX> 3,850,000
<INCOME-CONTINUING> 8,770,316
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,770,316
<EPS-PRIMARY> 0.46
<EPS-DILUTED> 0.44

</TABLE>

<S> <C>
<PERIOD-TYPE> 9-MOS
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0
0
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</TABLE>

<S> <C> <C> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 9-MOS 6-MOS 3-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1995
<PERIOD-START> JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1995
<PERIOD-END> DEC-31-1996 SEP-30-1996 JUN-30-1996 MAR-31-1996 DEC-31-1995
<CASH> 12,109,150 10,920,648 51,487,681 10,631,100 2,593,113
<SECURITIES> 50,339,193 49,981,280 4,877,378 6,827,732 7,909,160
<RECEIVABLES> 14,665,731 10,828,412 9,462,787 9,845,241 7,830,793
<ALLOWANCES> 0 0 0 0 0
<INVENTORY> 8,314,826 5,764,508 8,927,998 7,634,652 11,100,909
<CURRENT-ASSETS> 88,036,955 79,902,904 77,254,698 36,652,122 31,310,649
<PP&E> 839,415 763,799 733,802 664,297 558,999
<DEPRECIATION> 0 0 0 0 0
<TOTAL-ASSETS> 89,409,067 81,092,533 78,434,142 37,781,873 32,340,535
<CURRENT-LIABILITIES> 9,634,160 6,805,411 8,091,436 7,026,445 5,455,193
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0 0 0 0 0
0 0 0 0 0
<COMMON> 191,454 191,448 191,448 175,156 173,878
<OTHER-SE> 79,583,453 74,095,674 70,151,258 30,580,272 26,711,464
<TOTAL-LIABILITY-AND-EQUITY> 89,409,067 81,092,533 78,434,142 37,781,873 32,340,535
<SALES> 85,866,525 61,315,223 41,939,694 20,820,761 48,631,855
<TOTAL-REVENUES> 85,866,525 61,315,223 41,939,694 20,820,761 48,631,855
<CGS> 33,346,878 24,798,655 16,798,481 7,651,631 17,554,413
<TOTAL-COSTS> 30,777,045 22,185,405 16,227,332 8,325,018 18,679,356
<OTHER-EXPENSES> 0 0 0 0 0
<LOSS-PROVISION> 0 0 0 0 0
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<INCOME-PRETAX> 24,022,484 15,867,825 9,754,408 4,998,937 12,969,505
<INCOME-TAX> 8,500,000 5,825,000 3,606,000 1,898,000 (341,000)
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</TABLE>