-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FOgy0+VfXQHwBJ/yWAHlrx7sdT7bQeAGP0jh+nMtB6OJCes/qp8duOd4Wv5O4k1T FzVHSSkcJuFxrexsZzxHxw== 0000897101-02-000189.txt : 20020415 0000897101-02-000189.hdr.sgml : 20020415 ACCESSION NUMBER: 0000897101-02-000189 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020327 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNS INC /DE/ CENTRAL INDEX KEY: 0000814258 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 411580270 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16612 FILM NUMBER: 02589147 BUSINESS ADDRESS: STREET 1: PO BOX 39802 CITY: MINNEAPOLIS STATE: MN ZIP: 55439 BUSINESS PHONE: 6128206696 MAIL ADDRESS: STREET 1: PO BOX 39802 STREET 2: PO BOX 39802 CITY: MINNEAPOLIS STATE: MN ZIP: 55439 10-K 1 cns021471_10k.htm CNS, INC. FORM 10-K 12/31/2001 CNS, Inc. Form 10-K 12-31-2001

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, 2001

|_| 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: (952) 229-1500

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 18, 2002, assuming as market value the price of $6.15 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 $58,000,000.

As of March 18, 2002, the Company had outstanding 13,530,065 shares of Common Stock of $.01 par value per share.

Documents Incorporated by Reference: Portions of the Company’s Proxy Statement for its Annual Meeting of Stockholders to be held on May 15, 2002, are incorporated by reference into Part III of this Form 10-K.

Page
PART I

Item 1. Business................................................................................. 3
Item 2. Properties............................................................................... 17
Item 3. Legal Proceedings........................................................................ 17
Item 4. Submission of Matters to a Vote of Security Holders...................................... 17

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................... 18
Item 6. Selected Financial Data.................................................................. 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................. 20
Item 7A. Quantitative and Qualitative Disclosures about Market Risk............................... 28
Item 8. Financial Statements and Supplementary Data.............................................. 28
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................................. 28

PART III

Item 10. Directors and Executive Officers of the Registrant....................................... 29
Item 11. Executive Compensation................................................................... 30
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 30
Item 13. Certain Relationships and Related Transactions........................................... 30

PART IV

Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K................................................................... 31

         SIGNATURES........................................................................................     32
         EXHIBIT INDEX.....................................................................................     34
         FINANCIAL STATEMENTS..............................................................................    F-1

Forward-Looking Statements

Certain statements contained in this Annual Report on Form 10-K and other written and oral statements made from time to time by the Company do not relate strictly to historical or current facts but provide current expectations or forecasts of future events. As such, they are considered “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 and 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 similar words or expressions. It is not possible to foresee or identify all factors affecting the Company’s forward-looking statements and investors therefore should not consider any list of factors to be an exhaustive statement of all risks, uncertainties or potentially inaccurate assumptions. 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 reliant on sales of Breathe Right® nasal strips; (ii) the Company currently has a seasonal pattern of sales that is typically higher in the first and fourth quarters of each calendar year due to increased nasal strip usage during the cough/cold season and its revenues and earnings may be impacted by the severity of such season; (iii) the Company’s success and future growth will depend significantly on its ability to effectively market Breathe Right nasal strips and upon its ability to develop and achieve markets for additional products; (iv) the Company’s competitive position will, to some extent, be dependent on the enforceability and comprehensiveness of the patents on its Breathe Right nasal strip technology which have been, and in the future may be, the subject of litigation and could be narrowed as a result of the outcome of the reexamination of one such patent by the United States Patent and Trademark Office (see Item 1, “Patents, Trademarks and Proprietary Rights”); (v) the Company has faced and will continue to face challenges in successfully developing and introducing new products; (vi) the Company operates in competitive markets where recent and potential entrants into the nasal dilator segment pose competitive challenges (see Item 1, “Competition”); (vii) the Company is dependent upon contract manufacturers for the production of substantially all of its products; and (viii) the Company currently purchases most of its major components for its nasal strip products from different contract manufacturers that obtain the raw materials from a single supplier (see Item 1, “Manufacturing and Operations”).

PART I

Item 1. BUSINESS

General

CNS, Inc. (the “Company”) is in the business of developing and marketing consumer health care products, including the Breathe Right® nasal strip and the FiberChoice® chewable fiber tablet. The Company focuses on products that address important consumer needs within the aging well/self care market, including better breathing and digestive health.

The Company’s principal product, the Breathe Right nasal strip, improves breathing by reducing nasal airflow resistence. It can be effective in providing temporary relief for nasal congestion, reducing snoring and reducing breathing difficulties due to a deviated nasal septum. In 2000, the Company expanded its Breathe Right product line to include nasal strips for colds with Vicks® mentholated vapors that are sized for the entire family, and nasal strips for children that are available in multiple colors. Breathe Right nasal strips for colds with mentholated vapors were introduced in selected overseas markets in 2001.

The Company further extended the Breathe Right brand in 2001 through product licensing. The Company entered into an agreement to license the Breathe Right name for a new line of premium air filters for home furnace and air conditioning systems. In addition to expanding the Breathe Right brand and introducing

other new products, the Company is exploring possibilities for acquiring new consumer health care products that have established consumer brands, particularly those that complement the Company’s drug-free, better breathing platform. The Company is also considering opportunities for licensing new products and technologies.

The Company introduced its new FiberChoice® chewable fiber tablets in the second quarter of 2000. The FiberChoice product is an orange-flavored, chewable fiber tablet that offers consumers an effective, convenient and good-tasting way to supplement their daily intake of dietary fiber. In the fourth quarter of 1999, the Company introduced a product for race horses called the FLAIR^TM equine nasal strip. Invented by two veterinarians, the FLAIR equine nasal strip is a patented, drug-free product that enables horses to breathe more easily during strenuous exercise.

During 2001, the Company completed a restructuring and organizational realignment plan. The Company eliminated 20 positions across all areas for a 25% work force reduction. These actions enable the Company to focus its resources on better leveraging the success of the Breathe Right brand, both in the United States and abroad, operate the FiberChoice business more flexibly and efficiently, and reduce the Company’s investment in new products and business development.

Management

The Company’s management structure is organized into strategic business teams in order to expand the platform for building the Breathe Right brand and develop and launch new products: Breathe Right Brand Team; FiberChoice Team; International Team; FLAIR Team; and Business Development Team. The Company believes that its team focus enables the Company to more effectively implement its business strategies.

Breathe Right Brand Team. The Company’s Breathe Right Brand Team is responsible for the strategic development and management of the Breathe Right nasal strip business and other non-nasal strip products that carry the Breathe Right brand name. Breathe Right nasal strip products currently represent the cornerstone of the Company’s business. The Company intends to exploit new markets and opportunities that it believes exist for its current nasal strip products and plans to commercialize potential new Breathe Right brand products. The Company introduced two new products in the United States during the fall of 2000 to coincide with the cough/cold season, nasal strips for colds with Vicks mentholated vapors for the entire family and nasal strips for children. In connection with the fall 2002 cough/cold season, the Company intends to launch a new product that has been under development–Breathe Right Snore Relief^TM throat spray. This product will leverage the Company’s existing position in the better breathing/snoring product category and complement existing Breathe Right offerings.

FiberChoice Team. The Company introduced its FiberChoice chewable fiber tablets during the second quarter of 2000. The FiberChoice Product Team is responsible for the strategic development and management of the FiberChoice chewable fiber supplement business.

International Team. The Company began shipping Breathe Right nasal strips to new distributor partners in Europe, Australia and Japan during 2000. Breathe Right nasal strips for colds with mentholated vapors were introduced in selected overseas markets in 2001. The International Team is responsible for developing and managing the Company’s overseas business and its relationships with distributors and representatives in international markets. See Item 1, “International Distribution.”

FLAIR Team. The Company introduced the FLAIR equine nasal strip during 1999. The Company’s FLAIR Product Team is responsible for the strategic development and management of the FLAIR equine nasal

strip business. In March of 2002, the Company established an exclusive, worldwide distribution relationship for its FLAIR equine nasal strip product with Merial Limited, an affiliate of Merck & Co., Inc.

Business Development Team. The Business Development Team is committed to the expansion of the Company’s product base through the development, acquisition or licensing of promising consumer health care products, particularly those that complement the Company’s drug-free, better breathing platform. The Business Development Team is responsible for identifying and evaluating potential new products, inventions and other business prospects that will enable the Company to achieve its long-term growth and profit objectives, including opportunities for the acquisition of established product lines.

Products

Breathe Right Nasal Strips. The Breathe Right nasal strip is a nonprescription, single-use disposable device that improves breathing by opening the nasal passages. The Company has 510(k) clearance from the United States Food and Drug Administration (“FDA”) to market the Breathe Right nasal strip for improvement of nasal breathing, temporary relief of nasal congestion, elimination or reduction of snoring and temporary relief of breathing difficulties due to a deviated nasal septum. See Item 1, “Government Regulation.” The Breathe Right nasal strips come in tan, clear, mentholated and stars-for-kid’s varieties.

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 (kid’s, small/medium and large) to accommodate the range of nose sizes. The Breathe Right nasal strip is packaged for the consumer market in various quantities ranging between 8 to 38 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 ranging between $3.99 and $11.99 per box.

The Company expanded the Breathe Right nasal strip line with the introduction of the Breathe Right nasal strip with Vicks mentholated vapors and the Breathe Right nasal strip for kids in 2000. The Company has licensed the Vicks trademark from The Proctor & Gamble Company for use with the new mentholated nasal strip product. The Vicks mentholated nasal strip uses traditional Breathe Right strip technology but contains a soothing mentholated aroma for additional relief. The mentholated vapors are released when the strip surface is rubbed. The Company believes that its mentholated nasal strip product has increased the Company’s customer base for nasal strip products by more clearly communicating that Breathe Right nasal strips can ease the congestion associated with the common cold. The Kid’s Strips are sized specifically to fit children and include a brightly-colored version and a mentholated version.

Breathe Right Brand Products. The Breathe Right saline nasal spray is a non-habit forming, drug-free product that restores moisture to comfort and soothe dry, irritated nasal passages due to colds, allergies, dry air (low humidity), air pollution and the overuse of nasal decongestants. The Company intends to introduce additional non-nasal strip products in the future that carry the Breathe Right brand name to extend the product line. For example, the Company intends to launch a new product in connection with the fall 2002 cough/cold season – Breathe Right Snore Relief throat spray. The throat spray addresses a different cause of snoring than nasal strips and lubricates and soothes dry throats while a natural astringent firms loose tissues to reduce the vibrations that produce snoring. This product will leverage the Company’s existing position in the better breathing/snoring product category and complement existing Breathe Right product offerings.

FiberChoice Chewable Fiber Tablets. The Company introduced nationally its FiberChoice chewable fiber tablets in the second quarter of 2000. FiberChoice is an orange-flavored, chewable tablet that offers consumers an effective, convenient, good-tasting way to supplement their daily intake of dietary fiber. The active ingredient in FiberChoice tablets is fructan, a natural fiber source. Fructan is a prebiotic that helps promote the growth of healthy intestinal tract bacteria. The FiberChoice tablets can be taken without water and have been clinically proven to be as effective as powder alternatives. The product is available in both regular and sugar-free varieties and packaged in 160-count and 90-count bottles and 10-count rolls. In 2002, the Company expects to make the product also available in 36-count bottles.

FLAIR Equine Nasal Strips. The FLAIR equine nasal strip is a product for horses that capitalizes on the Company’s current nasal strip technology. Invented by two veterinarians, the FLAIR equine nasal strip is a patented, drug-free product that enables horses to breathe more easily during strenuous exercise. Results from several clinical trials indicate that the equine nasal strip product also reduces a bleeding condition in horses called exercise-induced pulmonary hemorrhaging (“EIPH”) that often occurs during and after races, high performance events and strenuous workouts. The FLAIR equine nasal strip holds open the nasal passages of the horses, which can breathe only through their noses, and reduces the effort required to breathe.

The FLAIR equine nasal strip was introduced for the first time during the Breeder’s Cup in November of 1999 at Gulfstream Park in Hallandale, Florida. Currently, FLAIR equine nasal strips are being sold in tack shops and equine supply stores and through equine catalogs. The Company’s FLAIR product remains a developing business but has not and is not expected to materially contribute to the Company’s revenues. The Company has recently established an exclusive distribution relationship with Merial Limited, an affiliate of Merck & Co., Inc., under which Merial has assumed all direct sales and marketing activities for the FLAIR equine nasal strip business.

Markets

Breathe Right Brand Product Line. The Breathe Right brand of products includes the Breathe Right nasal strip and the Breathe Right saline nasal spray. The Company intends to expand the Breathe Right brand in 2002 in connection with the fall cough/cold season with the introduction of its Breathe Right Snore Relief throat spray product.

Air impedance in the nose accounts for approximately one-half of the total airway resistance involved in the respiratory system (i.e., one-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 who have a common cold, allergies and sinusitis and by those who experience nasal obstruction due to a deviated nasal septum. The Company believes that people with chronic conditions such as snoring or allergies or with structural problems such as deviated septa may be more predisposed to use Breathe Right products on a regular or daily basis, while seasonal sufferers are likely to use Breathe Right products as needed. These conditions are aggravated when people have nasal congestion, thus increasing the opportunity for usage and consumer trial during the cough/cold season. People suffering from these conditions are currently the primary users of the Company’s Breathe Right products and are the main targets of its advertising.

In 1999, the Company began to emphasize the Breathe Right nasal strip position as a product that provides instant, drug-free relief for those suffering from nasal congestion and other symptoms due to the common cold, allergies and sinusitis. The Company’s advertising currently emphasizes the ability of Breathe Right nasal strips to provide immediate relief from nasal congestion due to colds.

The Company’s marketing efforts capitalize on the benefits of Breathe Right products to consumers in various, and often overlapping, consumer market segments:

•

Nasal Congestion Relief. Most Americans suffer some nasal congestion annually as a result of the common cold, while nasal congestion as a result of allergies affects approximately 35 million Americans. The Company believes that the Breathe Right nasal strip is often used as either an alternative or as an adjunct to decongestant drugs (including nasal sprays and oral decongestants). This broad cough/cold market represents a significant potential for the Breathe Right nasal strip. In 1999, the Company commenced marketing efforts aimed at repositioning the Breathe Right nasal strip as a product that provides relief for the common cold. In the fall of 2000, this repositioning as a product for colds was reinforced by the introduction of Breathe Right nasal strips with Vicks mentholated vapors. At the same time, the product line was extended into children’s sizes, with a brightly colored “stars” strip and a Kid Strip with Vicks mentholated vapors.

•

Snoring Relief. Based on results from clinical trials, Breathe Right products were effective in reducing snoring loudness in approximately 85% of the participants. This market remains very important to the Company since approximately 37 million people snore regularly, while another 50 million people snore occasionally. The Company believes that snorers can be targeted effectively and directly through relationship marketing efforts as well as through broad-based advertising.

•

Improved Breathing for Consumers with Deviated Septa. 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 nasal 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 Breathe Right nasal strip makes 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 have been conducted and add to the substantiation of the positive effects of the Breathe Right nasal strip during exercise. The Company continues to use athletes to endorse the Breathe Right nasal strip to increase the visibility of the product, which leads to greater awareness of the product and the Breathe Right brand.

FiberChoice Chewable Fiber Tablets. Approximately 10 million U.S. households annually purchase bulk fiber products, primarily to promote regularity and improve digestive health. The bulk fiber category represents approximately $325 million in U.S. retail sales. The Company believes there is a significant opportunity to expand this category due to both the aging of the baby-boomer generation and the marketing of a better consumer solution to existing dietary fiber products–FiberChoice chewable fiber tablets. As people age, they frequently develop digestive problems. People over 55 years old are three times more likely to purchase a bulk fiber supplement than those younger than 55. The first year the baby-boom generation turned 55 was in 2001. This generation is generally more active and demanding than their parents. These consumers search for solutions that do not hamper their active lifestyles. The Company believes that its FiberChoice chewable fiber tablet represents such a solution in that it provides an effective, convenient and good-tasting alternative for supplementing dietary fiber intake. The tablets can be taken anytime and anywhere, with or without water.

FLAIR Equine Nasal Strips. The FLAIR equine nasal strip is similar in concept to the human Breathe Right nasal strip adjusted to the unique anatomy and size of a horse. A horse breathes only through its nose, not through its mouth. During strenuous exercise, large amounts of air are inhaled and exhaled during which soft tissue on the side of the nose can collapse. The equine nasal strip supports those soft tissues so they do not collapse, which allows a horse to breathe more easily with less stress developing in the lungs. Results from several clinical trials indicate that horses wearing the FLAIR equine nasal strip use less energy to breathe and that the product reduces a bleeding condition in horses called exercise-induced pulmonary hemorrhaging (“EIPH”) that often occurs during races, high-performance events and strenuous workouts.

The FLAIR equine nasal strip could be used any time a horse is engaged in strenuous exercise. The Company estimates that in the U.S. there are approximately 1.3 million individual horse starts in racing competitions and over 1 million individual horse starts in non-racing competitions. Horses can benefit from the use of the FLAIR equine nasal strip in training as well as competition.

Business Strategies

The Company’s business strategy includes attempting to increase sales of its Breathe Right nasal strip and other Breathe Right brand products through advertising, expanding its Breathe Right product line with value added line extensions like Breathe Right nasal strips for colds with Vicks mentholated vapors and children’s nasal strips, maximizing the potential of recently introduced products and successfully introducing new products with an emphasis on drug-free, better breathing such as the Company’s Breathe Right Snore Relief throat spray.

Increasing New Consumer Product Trial and Increasing Product Usage. The Company uses a combination of advertising, sampling, promotions, public relations and celebrity endorsements to increase consumer awareness and to encourage consumer trial of the Breathe Right nasal strip. In 1999, the Company began to increase its emphasis on positioning the Breathe Right nasal strip as a product that provides instant, drug-free relief for those suffering from nasal congestion and other symptoms due to the common cold, allergies and sinusitis. The Company’s new advertising introduced the Breathe Right nasal strip for the common cold with Vicks mentholated vapors, emphasizing the ability of Breathe right nasal strips to provide instant, drug-free relief from nasal congestion. In 2001, the Company separately advertised Breathe Right nasal strips as a product that provides drug-free relief from nasal congestion and snoring.

Marketing New Breathe Right Brand Products. The Company believes that the Breathe Right brand name is one of its most valuable assets. In 1998, the Company introduced the Breathe Right saline nasal spray. The Company has also expanded the Breathe Right product line to include nasal strips for colds with Vicks mentholated vapors and nasal strips for children, both of which were introduced during the fall of 2000 in order to coincide with the cough/cold season. In 2001, the Company entered into an agreement to license the Breathe Right name for a new line of premium air filters for home furnace and air conditioning systems that target allergy sufferers. The Company intends to launch a new product in connection with the fall 2002 cough/cold season–Breathe Right Snore Relief throat spray. This product will leverage the Company’s existing position in the better breathing/snoring product category and complement existing Breathe Right offerings.

Expanding Company Presence in International Markets. The Company believes that there is a significant market potential for its products outside the United States. The Company is devoting significant resources to the development of its international business. The Company entered into agreements with new distributors and representatives for the distribution of the Company’s nasal strip products in Japan, Australia and a number of major markets in Europe in 2000 and in Hong Kong in 2001. The Company is considering additional distributors and representatives for distribution of its nasal strip products in international markets. During 2001, the Company launched its Breathe Right nasal strips with mentholated vapors in international markets in conjunction with each market’s cough/cold season. The Company believes that the network that it

has established for the international distribution of Breathe Right nasal strips will also enable the Company to build its international marketing and distribution capacity for other products. See Item 1, "International Distribution."

Acquiring, Developing and Marketing New Products. The Company plans to take advantage of its position as the drug-free, better breathing company and its marketing and distribution strengths by acquiring, developing or licensing the rights to new products that it believes have merit and by bringing them to market. The FiberChoice chewable fiber tablet was launched in the second quarter of 2000 and the FLAIR equine nasal strip was introduced in the fourth quarter of 1999. See Item 1, “Marketing Strategies.” In addition, the Company is evaluating opportunities for licensing new products and acquiring product lines that have an established base of consumer acceptance.

Marketing Strategies

Breathe Right Nasal Strips. The Company’s marketing efforts for Breathe Right products are directed to different consumer markets–the nasal congestion market and the snoring market. The Company has primarily used television advertising to market its products. The Company’s advertising focuses on the Breathe Right brand benefits of providing instant, drug-free relief from nasal congestion and snoring. The Company also uses product promotion programs, such as sampling, coupons and public relations activities to encourage product trial and repeat purchases. Introduction of the new Breathe Right nasal strips for colds with Vicks mentholated vapors has aided in expanding the Company’s penetration into this significant market. In 2001, the Company implemented its first on-line consumer promotion, the “Nosebowl.com sweepstakes”, and offered a trip for eight people to Super Bowl XXXVI. The promotion included an “Our Nose Bowl^TM” on-line game show where consumers could learn how Breathe Right nasal strips could help them. Marketing communications are generally designed to promote trial of Breathe Right brand products by increasing consumer awareness of the benefits of each product.

Marketing efforts for Breathe Right nasal strips as an aid in the prevention of snoring also included direct mail sampling and sampling through direct response television. In both programs, self-identified snorers were sent a sample of Breathe Right nasal strips along with a brochure explaining the causes of snoring and how the Company’s Breathe Right products can alleviate the condition.

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 35% of those in the United States who had purchased Breathe Right nasal strips have purchased additional product in the same year.

FiberChoice Chewable Fiber Tablets. The Company’s marketing efforts for the launch of FiberChoice chewable fiber tablets concentrated on advertising through television and magazines to consumers who are 55 or more years old. In addition, the Company distributed samples of the product and coupons to current users of bulk fiber products. The Company also used direct response television as a sampling vehicle. In these advertisements, consumers were invited to call a toll-free number to receive a free 10-count sample of FiberChoice fiber tablets. During the second half of 2001, the Company significantly reduced the level of spending on a national marketing strategy for FiberChoice fiber tablets in favor of more focused, regional efforts. The Company intends to test new marketing programs first regionally and, if effective, thereafter extend such programs to a national level.

FLAIR Equine Nasal Strips. The Company's marketing communications for FLAIR equine nasal strips has focused on the health benefits of using the product identified in clinical studies. FLAIR equine nasal

strips remain a developing business, but are not expected to have a material impact on the Company’s revenues. In March of 2002, the Company entered into a distribution relationship with Merial Limited, an affiliate of Merck & Co., Inc. Under that arrangement, Merial has the exclusive right to market and distribute the Company’s FLAIR equine nasal strips throughout the world.

New Products Strategy

The Company is committed to the future expansion of its product base through the acquisition and development of unique consumer health care products and technologies that have good market potential, particularly those that complement the Company’s drug-free, better breathing platform. The Company routinely evaluates the merit of product concepts and acquisition opportunities 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. For example, the Company has licensed the Vicks trademarks from The Proctor & Gamble Company for use with its new product, Breathe Right nasal strips for colds with Vicks mentholated vapors. The Company also seeks to extend the Breathe Right brand awareness through licensing to other better breathing products in new categories. In 2001, the Company entered into an arrangement to license the Breathe Right name for a new line of premium air filters for home furnace and air conditioning systems that target allergy sufferers. The Company intends to launch a new product in connection with the fall 2002 cough/cold season that has been under development–Breathe Right Snore Relief throat spray. This product will leverage the Company’s existing position in the better breathing/snoring product category and complement existing Breathe Right offerings.

Most, if not all, of the Company’s current products are regulated to varying degrees by the FDA and other regulatory bodies. See Item 1, “Government Regulation.” Products that the Company may acquire or develop in the future could also be subject to a variety of regulatory requirements. Some products will require extensive clinical studies and regulatory approvals prior to marketing and sale. There can be no assurance that any required regulatory approvals will be obtained or that the Company will market or sell any of these products.

Domestic Distribution

The Breathe Right nasal strip, the Breathe Right saline nasal spray and the FiberChoice chewable fiber tablets are sold primarily as consumer products in mass merchant chain stores, drug stores, grocery stores, warehouse clubs and military base stores in the United States. The Company sells its products through a direct sales force that concentrates on serving certain key retail accounts as well as through a network of independent sales representatives referred to in the industry as non-food general merchandise brokers. The Company uses direct sales people and broker groups who call on the mass merchant, chain drug, and grocery accounts and the wholesalers who serve primarily the independent drug stores and many of the grocery stores in the United States.

The Breathe Right nasal strip is typically positioned in the cough, cold and allergy sections of stores because it provides benefits similar to those obtained with other decongestant products. The Breathe Right saline nasal spray is also usually positioned in the same section of the store as the Breathe Right nasal strip since the products are typically used by those suffering from congestion, allergies and colds. FiberChoice chewable tablets are positioned in the bulk fiber and laxative sections of stores.

The Company’s retail customers include national chains of mass merchants, drug stores and grocery stores such as Wal-Mart, Kmart, Target, Eckerd, Walgreens, RiteAid, CVS, and Albertson’s and warehouse clubs such as Sam’s Club and Price Costco, as well as regional and independent stores in the same store categories. In 2001, one retail chain accounted for approximately 21% of 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 disrupt distribution of the Company’s products.

The FLAIR equine nasal strip has been historically sold by the Company primarily to trainers and owners in the horse racing industry through tack shops, equine catalogs, veterinarians and equine supply stores. In March of 2002, the Company established an exclusive distribution relationship for its FLAIR equine nasal strip product with Merial Limited, an affiliate of Merck & Co., Inc. Pursuant to that arrangement, Merial has assumed all direct sales and marketing activities for the product.

International Distribution

From August of 1995 through September of 1999, The 3M Company (“3M”) was the exclusive distributor of the Company’s Breathe Right nasal strip products outside the United States and Canada. The contractual relationship with 3M produced less than anticipated results in international markets. The Company believed that international markets required an increased level of focus, advertising and promotion to reach their potential. On September 30, 1999, the Company and 3M agreed to terminate the existing distribution agreement in a manner that enabled the Company to take a direct and immediate role in the sale, marketing and distribution of its nasal strip products in international markets. As part of the agreement, 3M also agreed not to sell any nasal dilator devices for a period of two years, which period ends on June 30, 2002.

In 2000, the Company established a broad-ranging international distribution system for the Breathe Right nasal strip business that consists of both sales representatives and reselling distributors. The Company has established relationships with distributors in Canada, Australia, Japan, Hong Kong and most of the major markets in Europe. The Company is also pursuing additional distribution opportunities. Sales are supervised by the Company from its Minnesota headquarters and by CNS International, Inc., a wholly-owned domestic subsidiary with one business manager in Europe. The business manager supervises and coordinates the activities of the distributors and sales representatives in Europe. Distributors are appointed largely on an exclusive basis, with territories consisting of one or more countries, and it is expected that this pattern will continue. The Company retains control over the packaging and advertising in all territories. Most shipments are made in bulk, either to reselling distributors who package for the local market, or to warehouse facilities abroad, where final packaging is arranged by the Company directly before shipment to retailers.

Manufacturing and Operations

The Company currently subcontracts with multiple manufacturers to produce Breathe Right nasal strips, Breathe Right saline nasal spray, FiberChoice chewable fiber tablets and FLAIR equine nasal strips. The Company does no in-house product production itself. These contract manufacturers provide full turnkey service and ship product to the Company that is completely packaged ready to be sold to retailers or provide semi-finished goods to the Company that require final packaging.

Each of the manufacturers makes Breathe Right nasals strips to the Company’s specifications using materials specified by the Company. The contract manufacturers have all entered into confidentiality agreements with the Company to protect the Company’s intellectual property rights. Company quality control and operations personnel periodically inspect the contract manufacturers in order to observe processes and procedures in an attempt to ensure compliance with FDA Good Manufacturing Practice Standards. Finished goods are also inspected to ensure that they meet quality requirements. The Company works closely with its material vendors and contract manufacturers to reduce scrap and waste, improve efficiency and improve yields to reduce the manufacturing costs of the product. The Company has received certification that it has established and maintains a quality system which meets the requirements of ISO 9001/EN 46001.

To ensure consistent quality and supply, the Company has multi-year contracts with converters that purchase most of the major components for the Breathe Right nasal strips directly from 3M. In 2001, the Company entered into a multi-year contract with 3M that provides for consistent supply, adherence to specifications and pricing. Although similar materials are currently available from other suppliers, the Company has historically utilized 3M components in its products. Although the Company believes that this relationship will not be disrupted or terminated, the inability to obtain sufficient quantities of these components or the need to develop alternative sources in a timely and cost-effective manner could adversely affect the Company’s operations until new sources of these components become available, if at all.

Competition

Breathe Right Nasal Strips. The market for decongestant products is highly competitive. The Company’s competition in the consumer market for decongestant products and other cold, allergy and sinus relief products consists primarily of pharmaceutical products, other nasal sprays and external nasal dilators, while competition in the snoring remedies market also consists primarily of nasal dilators, throat sprays, herbs, supplements and homeopathic remedies. Although the Company is currently the leading manufacturer of external nasal dilation products, Schering Plough Corp. entered the market in the fourth quarter of 1998 with an external nasal dilation device. Other companies have also recently entered the nasal dilation market with private label products. Many of the companies that compete with the Breathe Right nasal strip and other Breathe Right products, including Schering Plough, have significantly greater financial and operating resources than the Company. The Company has developed and implemented marketing strategies aimed at minimizing the impact of competitive products. As a result of these strategies and other steps taken by the Company, the Breathe Right nasal strip has maintained approximately 90% of the nasal dilator market despite the entry of other competitors into the market place.

The patents owned and licensed by the Company on the Breathe Right nasal strip will limit the ability of others to introduce competitive external nasal dilator products similar to the Breathe Right nasal strip in the United States. The Company intends to aggressively enforce its patent rights covering the Breathe Right nasal strip and has engaged in significant litigation to protect its patent rights. See Item 1, “Patents, Trademarks and Proprietary Rights.”

There can be no assurance that potential competitors will not be able to develop nasal dilation products which circumvent the Company’s patents. In addition, external nasal dilator products compete in the consumer markets with decongestant and sinus relief products and snoring remedies in many international markets where the Company does not yet have, and may not in the future have, patent protection on the Breathe Right nasal strip.

FiberChoice Chewable Fiber Tablet. The market for dietary fiber supplements is highly competitive and dominated by large companies with resources greater than the Company’s and established brands, such as Metamucil, Citrucel and FiberCon. The Company believes that its FiberChoice chewable fiber tablet is a unique product with significant market potential that offers consumers an effective, convenient and good-tasting alternative to existing products.

FLAIR Equine Nasal Strip. As an alternative to controversial drug therapies, the FLAIR equine nasal strip is a unique product which currently has no direct competition. The only competitive product currently available is the drug Furosemide (“Lasix”). Lasix is intended to alleviate a bleeding condition in the lungs of horses called exercise-induced pulmonary hemorrhaging (“EIPH”) that often occurs during races, high-performance events and strenuous workouts. Unlike Lasix, however, the FLAIR equine nasal strip has not been shown to be a race-day, performance enhancing product.

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 product safety and effectiveness.

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

The Company’s FiberChoice product is considered to be a dietary supplement and is regulated under the Federal Food, Drug, and Cosmetic 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 company obtain a license or approval from FDA before marketing dietary supplements in the United States. The FDA is developing implementing regulations for certain provisions of the DSHEA which will be published as final rules in the Federal Register.

There is no national regulatory body for horse racing. Consequently, approval from state horse racing commissions must be obtained on a state-by-state basis before the Company’s FLAIR equine nasal strip can be used during horse racing events. The Company has been working with state racing commissions to gain approval for the use of the FLAIR equine nasal strip in competition. To date, the FLAIR equine nasal strip can be used in horse races in most states, including the leading racing states of Kentucky, California and Florida, and most of the provinces in Canada. The product has not, however, been approved for racing in New York or New Jersey.

Sales of the Company’s products outside the United States are subject to regulatory requirements that vary widely from country to country. The Company has selected a third party to act as an “Authorized Representative” in the European Union. The Company believes that it has the necessary documentation to support affixing the “CE” mark, an international symbol of quality and compliance with applicable European

medical device directives, to the Company’s Breathe Right nasal strips in Europe. Regulatory approvals have also been obtained for the Breathe Right nasal strip in Australia and additional approvals in other jurisdictions will be sought by the Company as needed for all of its products.

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 other Company’s products. 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 and other products 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 has registered trademarks, owns two patents and one pending patent application, and has a number of patents through licenses which are used in connection with its business. Some of these patents and licenses cover significant product formulations, methods and designs for the Company’s current and possible future products. The Company believes its trademarks are important as protection for the Company’s image in the marketplace. The Company’s success is and will continue to be dependent upon the existence of and ability to protect its patents, trademarks and those under its licenses and the Company intends to take such steps as are necessary to protect its intellectual property rights.

There can be no assurance that the Company’s technology and proprietary rights will not be challenged on the grounds that its 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. Nor can there be any assurance that others will not attempt to challenge the validity or enforceability of the Company’s patents and licensed patents on the basis of prior art or introduce competitive products. In addition to seeking patent protection for its products, the Company also intends to protect its proprietary technologies and proprietary information as trade secrets.

The Company entered into license agreements pursuant to which the Company acquired from the licensors the exclusive rights to manufacture and sell the Breathe Right nasal strip in its various versions, the FiberChoice chewable fiber tablet and the FLAIR equine nasal strip. Specifically, the Company has the exclusive right pursuant to those license agreements to manufacture, sell and otherwise practice any invention claimed in the licensors’ patents issued in any country, including those that issue on pending applications. The Company is obligated to pay royalties to the licensors based on sales of the products typically including certain minimum royalty amounts in order to maintain its exclusivity.

The original licensor of the Breathe Right nasal strip 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. Seven of these patent applications have resulted in issued patents in the United States, including one with claims that cover the single-body construction of the Breathe Right nasal strip. The licensor of the Breathe Right nasal

strip also has one patent application which is currently pending. In addition, that licensor has obtained patent protection on the Breathe Right nasal strip in several foreign countries and has various applications pending which seek further patent protection in these and a number of additional countries. The Company, in addition to the two patents and one patent application pending in the U.S. mentioned above, has filed a corresponding patent application seeking protection in several foreign countries to protect certain rights to nasal dilation technology that it acquired.

The licensor of the FiberChoice chewable fiber tablet has filed one patent application with the U.S. Patent and Trademark Office seeking patent protection for different aspects of this product which remain pending. The later licensor of the Breathe Right aromatic nasal strip has filed at least four pending patent applications with the U.S. Patent and Trademark Office resulting in three issued patents so far. Eight patent applications for the FLAIR equine nasal strip have also been filed by the licensor thereof in the U.S. Patent and Trademark Office which have resulted in four issued U.S. patents. Each of these licensors has filed corresponding patent applications for acquiring patent protection in several foreign countries on the licensed products.

Although the Company believes that its owned and licensed patents on nasal strips will limit the ability of others to introduce competitive external nasal dilator products in the United States, there can be no assurance that the patents on the Breathe Right nasal strip, or any additional patents on this or other products that may be issued in the future, 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. The Company does, however, intend to aggressively enforce the patents covering nasal strips and its other products. In order to enforce any patents issued covering nasal strips, including the Breathe Right nasal strip, or any of its other products, the Company may have to engage in litigation which may result in substantial cost to the Company and counterclaims against the Company. Any adverse outcome of such litigation could have a negative impact on the Company’s business.

The Company has engaged in litigation to enforce its patent rights relating to the Breathe Right nasal strip. In 1999, the Company brought a suit in federal district court to enforce one of the licensed nasal strip patents containing the broadest claims and providing the most comprehensive protection. In the course of this suit, the defendant requested reexamination in the U.S. Patent and Trademark Office (the “Patent Office”) of the Company’s primary licensed patent. On September 29, 2000, the Patent Office issued an Office Action in Reexamination and rejected certain of the claims. Other claims that were not subject to reexamination remain in effect. The Company has joined the licensor in the exercise of its right to contest the action of the Patent Office and has provided reasons that it believes establish that the claims should not have been rejected. The Company and its licensor are also seeking to amend certain claims to provide the Company with additional protection under the patent. The final outcome of the reexamination by the Patent Office is therefore uncertain. Although an adverse ruling from the Patent Office would narrow the protection available for nasal dilators and limit the breadth of the Company’s patent protection, the Company believes that its current portfolio of both pending patent applications and issued patents will enable it to maintain significant patent protection for its nasal strip products.

The Company has registered its Breathe Right and FiberChoice trademarks in the United States and in several foreign countries and is seeking further registration of those trademarks and other trademarks. The Company has also licensed the right to a U.S. trademark registration for the FLAIR equine nasal strip product.

Employees

At March 18, 2002, the Company had 55 full-time employees and 1 part-time employee, of whom 14 were engaged in operations, 23 in general administration, and 19 in marketing and sales. 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 Stockholders and until their successors have been elected and have qualified.

Name and Age	Office

Daniel E. Cohen (49)	Chairman of the Board and Director

Marti Morfitt (44)	Chief Executive Officer and Director

M. W. Anderson, Ph.D (51)	Vice President of Product Development and Regulatory Affairs

David J. Byrd (48)	Vice President of Finance, Chief Financial Officer and Treasurer

John J. Keppeler (40)	Vice President of Worldwide Sales

Larry R. Muma (51)	Vice President of Operations

Teri P. Osgood (38)	Vice President of U.S. Marketing

Carol J. Watzke (54)	Vice President of Consumer Strategy

Daniel E. Cohen has served as the Company’s Chairman of the Board since 1993, its Chief Executive Officer from 1989 to June 2001 and a director since 1982. He also served as the Company’s Treasurer from 1982 to March of 1999. Mr. Cohen, a founder of the Company, is a medical doctor and board-certified neurologist.

Marti Morfitt has served as the Company’s President and a director since March 1998 and its Chief Executive Officer since June 2001. She also served as the Company’s Chief Operating Officer from 1998 to June 2001. From September of 1982 through February of 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 of 1997 to February of 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 Product Development and Regulatory Affairs since 1998,Vice President of Clinical and Regulatory Affairs from 1994 to 1998, and Vice President of Research and Development from 1990 to 1994. He has served in various other 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 of 1996 and its Treasurer since March of 1999. 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.

John J. Keppeler has served as the Company’s Vice President of Worldwide Sales since August of 1999, and has served as the Company’s Vice President of Sales from 1998 to 1999. From November of 1986 to June of 1998, Mr. Keppeler served in a series of sales and marketing positions of increasing responsibility with The Pillsbury Company, a Minneapolis-based manufacturer and distributor of food products, most recently serving as Director of Category & Customer Development for the Green Giant and Progresso Business.

Larry R. Muma has served as the Company’s Vice President of Operations since January of 2001. From May of 2000 to December of 2000, Mr. Muma served as Director of Supply Chain for Novartis, Inc., a worldwide manufacturer and distributor of health care and pharmaceutical products. From February of 1992 to April of 2000, Mr. Muma served in various operations positions of increasing responsibility with The Pillsbury Company, a Minneapolis-based manufacturer and distributor of food products, serving from February 1994 to April of 1999 as Vice President of Operations for Pillsbury North America and most recently from April of 1999 to April of 2000 as Vice President of Operations Frozen Division.

Teri P. Osgood has served as the Company’s Vice President of U.S. Marketing since December of 1999, of the Breathe Right Brand from April to December of 1999, and has served as the Company’s Vice President of New Business Commercialization from 1998 to April of 1999. From August of 1990 to July of 1998, Ms. Osgood 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 of 1997 to July of 1998 as Business Team Leader for Old El Paso, and from October of 1995 to May of 1997 as Business Team Leader for Pizza Snacks. Prior to joining Pillsbury, Ms. Osgood was employed in marketing by the Kimberly Clark Corp., from 1988 to 1990.

Carol J. Watzke has served as the Company’s Vice President of Consumer Strategy since July of 1998. Prior to joining the Company, Ms. Watzke served in a series of positions of increasing responsibility since 1974 with The Pillsbury Company, a Minneapolis-based manufacturer and distributor of food products, most recently serving as Consumer Insights Director from May of 1997 to July of 1998 and as Market Research Director, Green Giant Brands, from 1994 to 1997.

Item 2. PROPERTIES

The Company leases approximately 73,000 square feet of office, manufacturing and warehouse space in Eden Prairie, Minnesota. The lease expires in November of 2010 and contains a renewal option.

Item 3. LEGAL PROCEEDINGS

None.

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

None.

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

The Company’s Common Stock has been traded on The Nasdaq Stock Market under the symbol “CNXS” since April 8, 1994. The following table sets forth the high and low last sale prices of the Company’s Common Stock for the period indicated.

Fiscal Year Ended December 31, 2001	High	Low
First Quarter.......................................................................................	5.125	3.500
Second Quarter...................................................................................	6.080	3.250
Third Quarter......................................................................................	5.130	3.150
Fourth Quarter....................................................................................	5.950	3.660

Fiscal Year Ended December 31, 2000	High	Low
First Quarter........................................................................................	7.109	3.938
Second Quarter...................................................................................	5.000	3.500
Third Quarter......................................................................................	5.500	3.906
Fourth Quarter....................................................................................	4.125	3.125

On March 18, 2002, the last sale price of the Common Stock was $6.15 per share.

Shareholders

As of March 18, 2002, there were approximately 700 owners of record of Common Stock and an estimated 7,000 beneficial holders whose shares were registered in the names of nominees.

Dividends

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 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

The following selected financial data should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto together with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” all of which are included elsewhere in this Report. The Consolidated Statements of Operations and Balance Sheet data presented below as of and for the Years Ended December 31, 1999 through December 31, 2001 have been derived from the Company’s Consolidated Financial Statements included elsewhere in this Report, which have been audited by KPMG LLP, independent certified public accountants.

FINANCIAL HIGHLIGHTS
(In thousands, except per share amounts)


                                                               Years Ended December 31,
                                        ----------------------------------------------------------------------
                                           2001          2000           1999           1998           1997
                                        ----------   ------------   ------------   ------------   ------------

Net sales..........................      $ 83,934     $  68,892      $  46,050       $ 53,623       $ 66,957
Operating income (loss)............        (1,225)      (17,843)       (18,696)           701          9,644
Net income (loss)..................            81       (15,660)       (13,756)         2,982          8,770
Diluted net income (loss) per share          0.01         (1.09)         (0.89)          0.16           0.44

Working capital....................      $ 32,712     $  32,507      $  50,183       $ 72,025       $ 76,919
Total assets.......................        50,618        56,344         65,337         84,963         88,495
Stockholders’ equity...............        36,612        36,937         53,584         75,866         80,645

Item 7. 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 consolidated 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 consolidated financial statements and notes thereto.

Overview

The Company was founded in 1982. From 1987 until 1995, the Company designed, manufactured and marketed computer-based diagnostic devices for sleep disorders. In 1995, the Company divested itself of the assets related to its sleep disorders business to focus on the Breathe Right® nasal strip.

The Company obtained the exclusive 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. The Company has also received FDA clearance to market the Breathe Right nasal strip for the reduction or elimination of snoring, for the temporary relief of nasal congestion and for the temporary relief of breathing difficulties due to a deviated nasal septum.

In August 1995, the Company signed an exclusive international distribution agreement with the 3M Company (“3M”) to market Breathe Right nasal strips outside the U.S. and Canada. On September 30, 1999, the Company and 3M amended the distribution agreement in a manner that enabled the Company to regain control of the marketing, sales and distribution of Breathe Right nasal strips in international markets. In exchange for the one-time contract termination fee the international distribution agreement with 3M terminated on June 30, 2000. During 2000, the Company established an international distribution network that consists of both sales representatives and reselling distributors. The Company has reintroduced nasal strips in Europe, Japan and Australia.

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. During 1997, the Company became aware of a foreign reference to a nasal dilator, not commercially available. During 2000, the U.S. Patent and Trademark Office (“Patent Office”) reexamined the Company’s primary licensed patent and rejected certain claims. The Company has joined its licensor in the exercise of its right to contest the action of the Patent Office. The Company and its licensor have amended and are also seeking to amend certain claims to provide the Company with additional protection under the patent. The final outcome of the reexamination is uncertain. Although an adverse ruling could narrow the range of protection available for nasal dilators and limit the breadth of the Company’s patent protection, the Company believes that its current portfolio of both pending patent applications and issued patents will enable it to maintain significant patent protection for its nasal strip products.

During 1998, the Company strengthened its management team to add consumer packaged goods and new products experience and organized into focused business teams. The Company

completed positioning research work to expand the Breathe Right brand and developed a road map for new product development. During 1999 and 2000, the Company invested aggressively in marketing, selling and product development expenses to build the Breathe Right brand and launch additional products.

In 2000, the Company expanded its Breathe Right product line to include nasal strips for colds with Vicks® mentholated vapors that are sized for the entire family and nasal strips for children that are available in multiple colors. Breathe Right nasal strips for colds with mentholated vapors were introduced in selected overseas markets in 2001.

During 2000, the Company launched FiberChoice® chewable fiber tablets. The tablets are positioned in the bulk fiber supplement market and give the Company an entry into the digestive health products market. FiberChoice tablets can be taken without water and have been clinically proven to be as effective as powder alternatives.

In 2001, the Company announced a plan to streamline and realign the Company’s resources to better match its strategic goals and to focus on building the core businesses. The Company recorded a special charge related to costs associated with this plan. Approximately 25% of the workforce, from throughout the organization, were eliminated. These cost-cutting actions are expected to result in annual savings of approximately $2 to $2.5 million. Cost savings relating to this plan were realized beginning in July of 2001.

In 2002, the Company changed its fiscal year-end from December 31 to March 31. The first period to be reported in 2002 will be a three-month stub period ending March 31, 2002. Fiscal 2003 will be from April 1, 2002 through March 31, 2003.

Accounting Policies

In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management must make decisions which impact the reported amounts and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, management applies judgment based on its understanding and analysis of the relevant circumstances. Note 1 to the consolidated financial statements provides a summary of the significant accounting policies followed in the preparation of the financial statements.

The Company’s critical accounting policies include the following:

Sales Returns and Other Allowances, and Allowance for Doubtful Accounts. Revenue from sales is recognized at the time products are shipped less estimated sales returns and other allowances. Management must make estimates of potential future product returns and other allowances related to current period revenue. Management analyzes historical returns, current trends, and changes in customer and consumer demand when evaluating the adequacy of the sales returns and other allowances. The Company has established a reserve of $1.2 million for future sales returns and other allowances as of December 31, 2001. Similarly, management must make estimates of the uncollectability of accounts receivables. Management specifically analyzes customer account balances, historical bad debts, current economic trends and changes in the timing of customer payments. The balance of accounts receivable was $12.3 million net of the allowance for doubtful accounts of $500,000 as of December 31, 2001.

Inventory Valuation. Inventory is valued at lower of cost, determined on a first in first out basis, or market. The Company analyzes the cost and the market value of inventory items and establishes the appropriate valuation reserves. The Company has established a reserve of $326,000 as of December 31, 2001. Management believes that the inventory valuation results in carrying inventory at the lower of cost or market.

Accounting for Income Taxes. As part of the process of preparing financial statements, the Company is required to estimate income taxes, both state and federal. This process involves management estimating the actual current tax exposure together with assessing temporary differences resulting from different treatment for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. Management must then assess the likelihood that deferred tax assets will be utilized to offset future taxable income during the periods in which these temporary differences are deductible. Based on the level of historical taxable income and projections of future taxable income for the periods in which the deferred tax assets are deductible, management does not believe that it is more likely than not the Company will realize the benefits of these deductible differences. Accordingly, the Company has provided a valuation allowance of $9.3 million against the net deferred tax assets as of December 31, 2001.

Valuation of Product Rights. Management assesses the impairment of product rights whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that are considered important for the assessment include significant underperformance of a product line relative to projected or historical results, significant change in the market in relation to competitive products, significant negative industry or economic trends. Management currently does not believe that it is necessary to record an impairment charge at this time and that the carrying value of these assets will be recoverable.

Operating Results

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

Certain prior year amounts have been reclassified to conform to the current period’s presentation. These reclassifications had no impact on the operating loss or net loss for 2000 and 1999.

                                          THREE MONTHS ENDED                                             THREE MONTHS ENDED
                             ---------------------------------------------     YEAR       -----------------------------------------------  YEAR
                                                                              ENDED                                                        ENDED
                               MAR 31,     JUN 30,    SEP 30,    DEC 31,     DEC 31,     MAR 31,     JUN 30,     SEP 30,     DEC 31,      DEC 31,
                                 2001        2001       2001       2001        2001        2001        2001        2001        2001        2001
                             ----------- ----------- --------- ----------- ----------  ----------- ----------- ----------- ----------- -----------
                                            (IN THOUSANDS)

Domestic net sales .........  $ 22,284    $ 12,540    $14,847    $18,041    $ 67,712
International net sales ....     4,828       2,936      3,398      5,060      16,222
                              --------    --------    -------    -------    --------
 Net sales .................    27,112      15,476     18,245     23,101      83,934     100.0%      100.0%      100.0%       100.0%      100.0%
Cost of goods sold .........     8,706       5,557      6,059      7,376      27,698      32.1        35.9        33.2         31.9        33.0
                              --------    --------    -------    -------    --------   -------     -------        ----        -----       -----
  Gross profit .............    18,406       9,919     12,186     15,725      56,236      67.9        64.1        66.8         68.1        67.0
                              --------    --------    -------    -------    --------   -------     -------        ----        -----       -----
Operating expenses:
 Advertising and promotion .    17,579       8,635      4,371     11,363      41,948      64.8        55.8        24.0         49.2        50.0
 Selling, general and
  administrative ...........     4,766       3,519      3,247      3,051      14,583      17.6        22.7        17.8         13.2        17.4
 Special charges ...........         0       1,100          0       (170)        930       0.0         7.1         0.0         (0.7)        1.1
                              --------    --------    -------    -------    --------   -------     -------        ----        -----       -----
  Total operating expenses .    22,345      13,254      7,618     14,244      57,461      82.4        85.6        41.8         61.7        68.5
                              --------    --------    -------    -------    --------   -------     -------        ----        -----       -----
  Operating income (loss) ..    (3,939)     (3,335)     4,568      1,481      (1,225)    (14.5)      (21.5)       25.0          6.4        (1.5)
Interest income ............       362         345        269        330       1,306       1.3         2.2         1.5          1.4         1.6
                              --------    --------    -------    -------    --------   -------     -------        ----        -----       -----
  Income (loss) before
   income taxes ............  $ (3,577)   $ (2,990)   $ 4,837    $ 1,811    $     81     (13.2)%     (19.3)%      26.5%         7.8%        0.1%
                              ========    ========    =======    =======    ========   =======     =======        ====        =====       =====


                                            THREE MONTHS ENDED                   YEAR                    THREE MONTHS ENDED                   YEAR
                             -----------------------------------------------     ENDED    -----------------------------------------------    ENDED
                               MAR 31,     JUN 30,     SEP 30,     DEC 31,      DEC 31,     MAR 31,     JUN 30,     SEP 30,     DEC 31,     DEC 31,
                                 2000        2000        2000        2000        2000         2000        2000        2000        2000        2000
                             ----------- ----------- ----------- ----------- ------------ ----------- ----------- ----------- ----------- -----------
                                             (IN THOUSANDS)

Domestic net sales .........  $ 14,338    $ 12,697     $16,618    $ 19,082      $  62,735
International net sales ....       296         606       2,603       2,652          6,157
                              --------    --------     -------    --------      ---------
 Net sales .................    14,634      13,303      19,221      21,734         68,892     100.0%    100.0%      100.0%        100.0%      100.0%
Cost of goods sold .........     4,846       5,110       6,875       8,076         24,907      33.1      38.4        35.8          37.2        36.2
                              --------    --------     -------    --------      ---------   -------     -----       -----       -------     -------
  Gross profit .............     9,788       8,193      12,346      13,658         43,985      66.9      61.6        64.2          62.8        63.8
                              --------    --------     -------    --------      ---------   -------     -----       -----       -------     -------
Operating expenses:
 Advertising and promotion .    12,058       5,998       9,490      19,148         46,694      82.4      45.1        49.4          88.1        67.8
 Selling, general and
  administrative ...........     3,915       3,470       3,756       3,993         15,134      26.8      26.1        19.5          18.4        22.0
 Special charges ...........         0           0           0           0              0       0.0       0.0         0.0           0.0         0.0
                              --------    --------     -------    --------      ---------   -------     -----       -----       -------     -------
  Total operating expenses .    15,973       9,468      13,246      23,141         61,828     109.1      71.2        68.9         106.5        89.7
                              --------    --------     -------    --------      ---------   -------     -----       -----       -------     -------
  Operating loss ...........    (6,185)     (1,275)       (900)     (9,483)       (17,843)    (42.3)     (9.6)       (4.7)        (43.6)      (25.9)
Interest income ............       498         566         507         612          2,183       3.4       4.3         2.6           2.8         3.2
                              --------    --------     -------    --------      ---------   -------     -----       -----       -------     -------
  Loss before income taxes .  $ (5,687)   $   (709)    $  (393)   $ (8,871)     $ (15,660)    (38.9)%    (5.3)%      (2.0)%       (40.8)%    (22.7)%
                              ========    ========     =======    ========      =========   =======     =====       =====       =======     =======




                                            THREE MONTHS ENDED                     YEAR                    THREE MONTHS ENDED                   YEAR
                             -----------------------------------------------       ENDED    -----------------------------------------------    ENDED
                               MAR 31,     JUN 30,     SEP 30,     DEC 31,        DEC 31,     MAR 31,     JUN 30,     SEP 30,     DEC 31,     DEC 31,
                                 1999        1999        1999        1999          1999         1999        1999        1999        1999        1999
                             ----------- ----------- ----------- -----------   ------------ ----------- ----------- ----------- ----------- -----------
                                             (IN THOUSANDS)

Domestic net sales .........  $ 11,811    $   7,994   $ 10,151    $ 15,106      $  45,062
International net sales ....       123          191        312         362            988
                              --------    ---------   --------    --------      ---------
 Net sales .................    11,934        8,185     10,463      15,468         46,050       100.0%      100.0%      100.0%      100.0%      100.0%
Cost of goods sold .........     4,688        3,629      3,992       6,049         18,358        39.3        44.3        38.2        39.1        39.9
                              --------    ---------   --------    --------      ---------     -------     -------     -------     -------     -------
  Gross profit .............     7,246        4,556      6,471       9,419         27,692        60.7        55.7        61.8        60.9        60.1
                              --------    ---------   --------    --------      ---------     -------     -------     -------     -------     -------
Operating expenses:
 Advertising and promotion .     9,749        2,864      2,915      12,576         28,104        81.7        35.0        27.9        81.3        61.0
 Selling, general and
  administrative ...........     3,463        3,164      3,452       1,859         11,938        29.0        38.7        33.0        12.0        25.9
 Special charges ...........         0            0      6,345           0          6,345         0.0         0.0        60.6         0.0        13.8
                              --------    ---------   --------    --------      ---------     -------     -------     -------     -------     -------
  Total operating expenses .    13,212        6,028     12,712      14,435         46,387       110.7        73.6       121.5        93.3       100.7
                              --------    ---------   --------    --------      ---------     -------     -------     -------     -------     -------
  Operating loss ...........    (5,966)      (1,472)    (6,241)     (5,016)       (18,695)      (50.0)      (18.0)      (59.6)      (32.4)      (40.6)
Interest income ............       899          698        643         598          2,838         7.5         8.5         6.1         3.9         6.2
                              --------    ---------   --------    --------      ---------     -------     -------     -------     -------     -------
  Loss before income taxes .  $ (5,067)   $    (774)  $ (5,598)   $ (4,418)     $ (15,857)      (42.5)%     ( 9.5)%     (53.5)%     (28.6)%     (34.4)%
                              ========    =========   ========    ========      =========     =======     =======     =======     =======     =======

2001 Compared to 2000

Net Sales. Net sales for 2001 of $83.9 million showed a 21.8% increase over 2000 sales of $68.9 million. The sales increase is the result of growth in all areas of the Company’s business. Domestic sales of Breathe Right nasal strips grew to $59.8 million, representing an increase of 8.7% over 2000 sales of $55.0 million. FiberChoice tablet sales for 2001 grew to $7.9 million from $7.3 million for the previous year, representing an increase of 8.2%, primarily as the result of a full year of sales activity.

International sales increased by 161.3% to $16.2 million dollars compared to 2000 sales of $6.2 million. This increase was the result of a full year of distribution in Japan, Europe and Australia as well as the launch of Breathe Right strips for colds with mentholated vapors in selected countries.

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 advertising levels and 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.

Gross Profit. Gross profit was $56.2 million for 2001 compared to $44.0 million for 2000. Gross profit as a percentage of net sales increased to 67.0% for 2001 compared to 63.8% for 2000. Gross profit in 2000 was unfavorably impacted by the lower gross profit on 10-count FiberChoice chewable tablets, disposal of an excess inventory of pillow covers and higher costs associated with expediting inventory purchases and deliveries.

Advertising and Promotion Expenses. Advertising and promotion expenses were $41.9 million for 2001 compared to $46.7 million for 2000. Advertising and promotion expenses as a percentage of net sales decreased to 50.0% in 2001 from 67.8% in 2000. This decrease in spending rate was the result of a planned lower support level for FiberChoice tablets the year following its introduction and the elimination of less effective expenditures for the Breathe Right brand.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $14.6 million for 2001 compared to $15.1 million for 2000. Selling, general and administrative expenses as a percentage of net sales decreased to 17.4% compared to 22.0% for 2000. This decrease was primarily the result of the corporate restructure that included a workforce reduction and that enabled the Company to streamline its resources to focus on building the core businesses.

Special Charges. The Company recorded a special charge of $930,000 in 2001 for the costs of implementing the Company’s corporate restructuring plan to streamline and realign the Company’s resources. The charge was primarily for severance benefits.

Investment Income. Investment income was $1.3 million for 2001 compared to $2.2 million for 2000. The decrease in investment income was the result of a decrease in funds invested and market interest rates.

Income Tax Benefit (Expense). There was no income tax provision for 2001 due to tax loss carryforwards.

2000 Compared to 1999

Net Sales. Net sales were $68.9 million for 2000 compared to $46.1 million for 1999. Sales increased by 49.6% for the year due to the impact of increased advertising expenditures and new product introductions. For the year 2000, domestic sales increased to $62.7 million from $45.1 for 1999. The increase reflects increased Breathe Right nasal strip sales and shipments of FiberChoice chewable tablets. Breathe Right strip sales grew due to initial shipments of the Company’s new mentholated and kids strips and the growth of the core Breathe Right nasal strip business. In addition, 1999 sales were reduced by reserves for returns of product in connection with the introduction of new packaging that year.

International sales increased to $6.2 million for 2000 from $988,000 for 1999. The higher level of sales reflects the reintroduction of Breathe Right nasal strips through the Company’s new international distributors in Japan, Europe and Australia. The distribution agreement with the Company’s previous international distributor was terminated effective June 30, 2000.

Gross Profit. Gross profit was $44.0 million for 2000 compared to $27.7 million for 1999. Gross profit as a percentage of net sales was 63.8% for 2000 compared to 60.1% for 1999. Gross profit in 2000 was unfavorably impacted by the lower gross profit on FiberChoice chewable tablets, especially the 10-count trial size tubes. The Company also disposed of an excess inventory of pillow covers and incurred higher costs associated with expediting inventory purchases and deliveries. During the third and early fourth quarters, customer orders exceeded forecasts, resulting in additional costs to meet customer delivery schedules. The gross profit percentage was lower in 1999, primarily due to costs for the transition of Breathe Right nasal strips to new product packaging.

Advertising and Promotion Expenses. Advertising and promotion expenses were $46.7 million for 2000 compared to $28.1 million for 1999. Marketing and selling expenses as a percentage of net sales increased to 67.8% in 2000 from 61.0% in 1999, reflecting the planned investment in advertising needed to return the Breathe Right brand to growth, relaunch Breathe Right nasal strips in key international markets and launch FiberChoice tablets.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $15.1 million for 2000 compared to $11.9 million for 1999. This increase was primarily from infrastructure to support the growing business and business development expenses to identify future product opportunities. General and administrative expenses as a percentage of net sales decreased to 22.0% in 2000 from 25.9% in 1999 as a result of the higher level of sales in 2000.

Special Charge. In 1999, the Company recorded a special charge relating to a contract termination fee of $6.3 million. This special charge represents a one-time payment to 3M, the Company’s international distributor, to terminate the international distribution agreement. The agreement allowed the Company to regain control of the international business on a phased schedule that was completed June 30, 2000.

Investment Income. Investment income was $2.2 million for 2000 compared to $2.8 million for 1999. The decrease was primarily the result of a decrease in investments.

Income Tax Benefit (Expense). There was no income tax provision for 2000 due to tax loss carryforwards.

Seasonality

The Company believes that a portion of Breathe Right nasal strip use is 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 cough/cold season.

Liquidity and Capital Resources

At December 31, 2001, the Company had cash, cash equivalents and marketable securities of $27.3 million and working capital of $32.7 million.

Operating Activities. The Company used cash in operations of $2.8 million in 2001 primarily due to a decrease in operating liabilities. The Company used cash in operations of $4.4 million and $12.1 million in 2000 and 1999, respectively. The decreased cash flow in 2000 was primarily due to the net loss for the year offset by an increase in operating liabilities.

Investing Activities. Sales and maturities of marketable securities exceeded purchases by $10.5 million in 2001. Net proceeds were used primarily to fund the cash used in operations and purchase treasury shares. Sales and maturities of marketable securities exceeded purchases by $9.2 million in 2000. Net proceeds were used to fund the cash used in operations, purchase property and equipment and purchase treasury shares. Marketable securities purchased consisted of cash equivalents, corporate bonds, U.S. Government obligations and municipal bonds.

The Company purchased $400,000 and $2.0 million of property and equipment in 2001 and 2000, respectively, primarily associated with the Company’s move to different facilities.

Financing Activities. The Company purchased 202,000 shares of its common stock for $1.0 million in 2001 and purchased 396,000 shares for $1.5 million in 2000. These treasury shares will 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 $288,000 in 2001 and $103,000 in 2000 from the exercise of stock options and issuance of stock under the employee stock purchase plan.

Significant Agreements and Lease Obligations. The Company has entered into certain agreements and leases in order to secure product rights and office space. The following is a summary of significant agreements and lease obligations:



                               Minimum      Operating
Year Ending December 31,      Royalties      Leases        Total


2002 .....................     $ 1,070      $   733      $ 1,803
2003 .....................       1,070          744        1,814
2004 .....................       1,070          727        1,797
2005 .....................       1,070          740        1,810
2006 .....................       1,070          755        1,825
Later years ..............                    3,104
                                            -------
Total ....................                  $ 6,803
                                            -------

The Company has agreements that exclusively license intellectual property rights for certain products. Royalties due under these agreements are based on various percentages to net sales. The licensing agreements are valid for the lives of the related patents, however, they may be terminated earlier under certain conditions. Total minimum royalties are not determinable since royalties

continue for the life of current and potential future patents related to the licensed intellectual property. The Company has entered into operating leases for office space and office equipment. Leases expire at various dates beginning in 2002 through 2010. Management is not aware of any significant agreements or obligations that would have a material negative impact upon the Company’s short-term or long-term liquidity.

The Company believes that its existing funds will be sufficient to support its planned operations for the foreseeable future.

Recent Accounting Pronouncements

In 2000, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-14, “Accounting for Certain Sales Incentives”. This EITF requires companies to present in their statements of operations, certain sales incentives as sales allowances, resulting in a reduction of net sales. The Company currently records sales incentives covered by this EITF as operating expenses. The Company will be required to adopt this EITF beginning with the quarter ending March 31, 2002. If the Company would have applied the presentation set forth in this issue in 2001, 2000 and 1999, net sales would have been reduced by $1.1, $1.5 and $3.1 million, respectively. Operating expenses would have also been reduced by the same amounts in the corresponding years. This issue does not impact operating income (loss) for any of these years.

In 2001, the EITF reached a consensus on Issue No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller”. This EITF requires companies to present in their statements of operations, certain consideration paid to a purchaser of the company’s products as sales allowances, resulting in a reduction of net sales. The Company currently records costs covered by this EITF as operating expenses. The Company plans on adopting this EITF beginning with the quarter ending March 31, 2002. The Company is in the process of evaluating this EITF and its potential impact.

In 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This statement supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”. The statement retains the previously existing accounting requirements related to the recognition and measurement of the impairment of long-lived assets to be held and used while expanding the measurement requirements of long-lived assets to be disposed of by sale. It also expands the previously existing reporting requirements for discontinued operations to include a component of an entity that either has been disposed of or is classified as held for sale. The Company is required to implement SFAS No. 144 beginning with the quarter ending March 31, 2002. Management does not expect this statement to have a material impact on the Company’s consolidated financial position or results of operations.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s market risk exposure is primarily interest rate risk related to its cash and cash equivalents and investments in marketable securities. The Company has investment guidelines which limit the types of securities in which it may invest as well as the length of maturities. No investment may exceed 36 months in maturity and the weighted average life of the portfolio may not exceed 18 months.

The table below provides information about the Company’s cash and cash equivalents and marketable securities as of December 31, 2001:


                                                                      (In thousands)
                                                                Cost                  Fair Value
                                                              --------                 ----------

          Due within one year...........................      $19,022                   $19,158
          Due after one year through three years........        7,911                     8,137
                                                              -------                   -------
                                                              $26,933                   $27,295
                                                              =======                   =======

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Consolidated Balance Sheets of the Company as of December 31, 2001 and 2000, and the related Consolidated Statements of Operations, Stockholders’Equity and Comprehensive Income (Loss), and Cash Flows for each of the years in the three-year period ended December 31, 2001, the Notes to the Consolidated Financial Statements and the Report of KPMG LLP, independent certified public accountants, are listed under Item 14 of this Report.

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

None.

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors

The following sets forth certain information with respect to the Company’s directors:

Daniel E. Cohen, 49, has served as the Company's Chairman of the Board since 1993 and has served as a director of the Company since its formation in 1982. Mr. Cohen also served as the Company's Chief Executive Officer from 1989 to June 2001 and as Treasurer from 1982 to March 1999. Mr. Cohen, a founder of the Company, is a medical doctor and board-certified neurologist.

Patrick Delaney, 59, has served as a director of the Company since 1983 and as the Company's Secretary since 1995. Mr. Delaney is a partner in the Minneapolis-based law firm of Lindquist & Vennum P.L.L.P., counsel to the Company. He has been in the private practice of law since 1967. He is also a director of Community First Bankshares, Inc., a multi-bank holding company, and the secretary of Cardia, Inc., a manufacturer of medical devices.

R. Hunt Greene, 51, has served as a director of the Company since 1985. Mr. Greene has been an investment banker for over twenty years. He is presently Managing Director and Member of Greene Holcomb &Fisher LLC (“GH&F”), a Minneapolis investment banking firm that was formed in 1995. GH&F has provided the Company with certain financial advisory and investment banking services from time to time since 1996.

Andrew J. Greenshields, 64, has served as a director of the Company since 1986. Mr. Greenshields has been President of Pathfinder Ventures, Inc., Minneapolis, Minnesota, since 1980. He is also a general partner of Pathfinder Venture Capital Fund III and a general partner of Spell Capital Partners, LP, both of which are Minneapolis-based financial limited partnerships. Mr. Greenshields is also a director of Aetrium, Inc., a manufacturer of semi-conductor handling equipment.

H. Robert Hawthorne, 57, has served as a director of the Company since 1999. Mr. Hawthorne has been Chief Executive Officer of Ocean Spray Cranberries, Inc., a Boston-based food and beverage company, since February 2000. From 1997 to 1999, Mr. Hawthorne served as a director, President and Chief Executive Officer of Select Comfort Corporation, a Minneapolis-based company that manufactures air beds and sleep related products. From 1986 to 1997, Mr. Hawthorne 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 February 1992 to December 1997 as President of The Pillsbury Brands Group, a subsidiary of The Pillsbury Company.

Marti Morfitt, 44, has served as the Company’s President and Chief Executive Officer since June 2001, its President and Chief Operating Officer from March 1998 to June 2001. Ms. Morfitt has served as a director of the Company since 1998. From September 1982 to 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.

Richard A. Peddie, 55, has served as a director of the Company since July 19, 2001. Mr. Peddie currently serves as President and Chief Executive Officer of Canadian-based Maple Leaf Sports &

Entertainment, Ltd., which owns the Toronto Raptors Basketball Club, the Toronto Maple Leafs Hockey Team and Air Canada Centre, and has served in that capacity since 1998. From 1996 to 1998, Mr. Peddie served President and Chief Executive Officer of the Toronto Raptors Basketball Club. From 1994 to 1996, Mr. Peddie served as President and Chief Operating Officer of NetStar Communications, Inc., a Canadian-based broadcast company. From 1989 to 1994, Mr. Peddie served as the President and Chief Executive Officer of Stadium Corporation of Ontario (SkyDome). From 1985 to 1989, Mr. Peddie served as President and Chief Executive Officer of Pillsbury Canada Limited, a subsidiary of The Pillsbury Company and manufacturer and distributor of food products. From 1973 to 1985, Mr. Peddie served in positions of increasing responsibility with General Foods Limited, a manufacturer and distributor of food products, most recently serving from 1983 to 1985 as the President of the Hostess Food Products Division.

Richard W. Perkins, 71, has been a director of the Company since 1993. Mr. Perkins has been President, Chief Executive Officer and a director of Perkins Capital Management, Inc., a Minneapolis-based investment management company, since 1985. He is also a general partner of Spell Capital Partners, LP, a Minneapolis-based venture capital limited partnership. He is also a director of the following publicly-held companies: Bio-Vascular, Inc., a manufacturer of medical products; Intellefilm Corp., a producer of television and internet commercials; PW Eagle, Inc., a manufacturer of plastic pipe; Lifecore Biomedical, Inc., a medical device company; Nortech Systems, Inc., a contract manufacturer for the electronics industry; Quantech, Ltd., a development stage medical device company; Vital Images, Inc., a medical diagnostic software company; and Paper Warehouse, Inc., a retailer specializing in party supplies and paper products.

Certain other 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 Stockholders to be held on May 15, 2002 (the “2002 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.

Executive Officers

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 Company’s 2002 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 2002 Proxy Statement and is incorporated herein by reference.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not Applicable.

PART IV

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

(a)	Documents filed as part of this Report:


                                                                                                          Form 10-K
                                                                                                        Page Reference
                                                                                                        --------------

           1.     Financial Statements.

                  Independent Auditors' Report.............................................................F-1
                  Consolidated Statements of Operations for the Years Ended
                     December 31, 2001, 2000 and 1999......................................................F-2
                  Consolidated Balance Sheets as of December 31, 2001 and 2000.............................F-3
                  Consolidated Statements of Stockholders' Equity and Comprehensive
                     Income (Loss) for the Years Ended December 31, 2001, 2000 and 1999....................F-4
                  Consolidated Statements of Cash Flows for the Years Ended
                     December 31, 2001, 2000 and 1999......................................................F-5
                  Notes to Consolidated Financial Statements...............................................F-6

           2.     Financial Statement Schedules.

                  None.

           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, 2001. On February 7, 2002, the Company filed a report on Form 8-K announcing that the Board of Directors adopted a resolution changing the Company's fiscal year end from December 31 to March 31.

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 25, 2002	By /s/ Marti Morfitt Marti Morfitt Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on March 25, 2002 on behalf of the Registrant in the capacities indicated.

(Power of Attorney and Signatures)

Each person whose signature appears below constitutes and appoints DANIEL E. COHEN and MARTI MORFITT as his or her true and lawful attorneys-in-fact and agents, each acting alone, with the full power of substitution and resubstitution, for him or her and in his or her 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 or she might or could do in person, hereby ratifying and confirming all said attorneys-in-fact and agents, each acting alone, or his or her substitute or substitutes, may lawfully do or cause to be done by virtue thereof.

/s/ Marti Morfitt
Marti Morfitt
Chief Executive Officer and Director
(Principal Executive Officer)

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

/s/ Daniel E. Cohen
Daniel E. Cohen
Chairman of the Board and Director

/s/ Patrick Delaney
Patrick Delaney
Director

/s/ H. Robert Hawthorne
H. Robert Hawthorne
Director

/s/ R. Hunt Greene
R. Hunt Greene
Director

/s/ Andrew J. Greenshields
Andrew J. Greenshields
Director

/s/ Richard A. Peddie
Richard A. Peddie
Director

/s/ Richard W. Perkins
Richard W. Perkins
Director

CNS, INC.
EXHIBIT INDEX

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 and Restated By-Laws.

4.1	Form of Rights Agreement dated July 20, 1995 between CNS, Inc. and Norwest Bank Minnesota, N.A. as Rights Agent (incorporated by reference to Exhibit 1 to the Company’s Registration Statement on Form 8-A/A, Commission File No. 0-16612).

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, as amended (incorporated by reference to Exhibits 4.1 and 4.2 to the Company’s Registration Statement on Form S-8, Commission File No. 33-68310).

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*

CNS, Inc. 1994 Amended Stock Plan (incorporated by reference to Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997).

10.5*

CNS, Inc. 2000 Stock Option Plan (incorporated by reference to Exhibit A of the Definitive Proxy Statement for the Company’s Annual Meeting of Stockholders that was held on May 3, 2000).

10.6**

License Agreement dated January 30, 1992 between the Company and Creative Integration and Design, Inc. (incorporated by reference to Exhibit 10.11 to the Company’s Registration Statement on Form S-2, Commission File No. 33-46120).

10.7**

License Agreement dated November 10, 1997 between the Company and Onesta Nutrition, Inc. (incorporated by reference to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the year ending December 31, 1999 (the “1999 Form 10-K”)).

10.8**

License Agreement dated March 12, 1999 between the Company and WinEase LLC (incorporated by reference to Exhibit 10.10 to the Company’s 1999 Form 10-K).

10.9**

Addendum to License Agreement between the Company and WinEase LLC dated March 21, 2002.

10.10**

License Agreement dated June 21, 1999 between the Company and Peter Cronk and Kristen Cronk (incorporated by reference to Exhibit 10.11 of the 1999 Form 10-K).

10.11**

License Agreement dated March 1, 2000 between the Company and Proctor and Gamble (incorporated by reference to Exhibit 10.10 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000 (the “2000 Form 10-K”)).

10.12

Amendment to Trademark License Agreement effective as of March 20, 2001 by and between the Company and the Procter & Gamble Company (incorporated by reference to Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2001).

10.13**

Second Amendment to Trademark License Agreement effective as of April 27, 2001 by and between the Company and the Procter & Gamble Company (incorporated by reference to Exhibit 10.12 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2001).

10.14**

Distributor Agreement between the Company and Eisai Co., Ltd. dated August 1, 2000 (incorporated by reference to Exhibit 10.11 to the Company’s 1999 Form 10-K).

10.15**

Repackaging Agreement between the Company and Herusu, Co., Ltd. dated August 1, 2000 (incorporated by reference to Exhibit 10.12 to the Company’s 2000 Form 10-K).

10.16**

Supply Agreement between the Company and Tapemark, Inc. dated October 15, 2001 (incorporated by reference to Exhibit 10.15 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2001 (the “September 30, 2001 Quarterly Report”)).

10.17**

Supply Agreement between the Company and WebTec Converting, LLC dated October 5, 2001 (incorporated by reference to Exhibit 10.16 to the September 30, 2001 Quarterly Report).

10.18**

Medical Specialties Material Purchase Agreement between the Company and Minnesota Mining and Manufacturing Company dated August 1, 2001 (incorporated by reference to Exhibit 10.17 to the September 30, 2001 Quarterly Report).

10.19*

Employment Agreement between the Company and Daniel E. Cohen dated February 12, 1999 (incorporated by referenced to Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998 (the “1998 Form 10-K”)).

10.20*

First Amendment to Executive Employment Agreement between the Company and Daniel E. Cohen dated June 29, 2001 (incorporated by reference to Exhibit 10.19 to the September 30, 2001 Quarterly Report).

10.21*

Employment Agreement between the Company and Marti Morfitt dated February 12, 1999 (incorporated by referenced to Exhibit 10.10 to the 1998 Form 10-K).

10.22*

Employment Agreement between the Company and Kirk P. Hodgdon dated February 12, 1999 (incorporated by referenced to Exhibit 10.11 to the 1998 Form 10-K).

10.23*

Employment Agreement between the Company and David J. Byrd dated February 12, 1999 (incorporated by referenced to Exhibit 10.12 to the 1998 Form 10-K).

10.24*

Employment Agreement between the Company and John J. Keppeler dated February 12, 1999 (incorporated by referenced to Exhibit 10.13 to the 1998 Form 10-K).

10.25*

Employment Agreement between the Company and Teri P. Osgood dated February 12, 1999 (incorporated by referenced to Exhibit 10.14 to the 1998 Form 10-K).

10.26*

Employment Agreement between the Company and Carol J. Watzke dated February 12, 1999 (incorporated by referenced to Exhibit 10.15 to the 1998 Form 10-K).

10.27*

Employment Agreement between the Company and M. W. Anderson dated February 12, 1999 (incorporated by referenced to Exhibit 10.17 to the 1998 Form 10-K).

10.28*

Employment Agreement between the Company and Larry R. Muma dated January 2, 2001 (incorporated by reference to Exhibit 10.21 to the 2000 Form 10-K).

21.1	Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 to the 1999 Form 10-K).

23.1	Consent of KPMG LLP.

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

__________

*Indicates Compensatory Agreement.

**Certain portions of this Exhibit have been deleted and filed separately with the Commission pursuant to a request for confidential treatment under Rule 24b-2. Spaces corresponding to the deleted portions are represented by brackets with asterisks.

Independent Auditors’ Report

The Board of Directors and Stockholders
CNS, Inc.:

We have audited the accompanying consolidated balance sheets of CNS, Inc. and subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of CNS, Inc. and subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.

/s/ KPMG LLP

Minneapolis, Minnesota
January 22, 2002

F-1

CNS, INC.
Consolidated Statements of Operations
Years ended December 2001, 2000 and 1999
(in thousands, except per share amounts)



                                                            2001          2000           1999
- -------------------------------------------------------------------------------------------------

Net sales                                                 $ 83,934     $  68,892      $  46,050
Cost of goods sold                                          27,698        24,907         18,358
- ------------------------------------------------------    --------     ---------      ---------
      Gross profit                                          56,236        43,985         27,692
- ------------------------------------------------------    --------     ---------      ---------
Operating expenses:
 Advertising and promotion                                  41,948        46,694         28,104
 Selling, general and administrative                        14,583        15,134         11,938
 Special charges                                               930             0          6,345
- ------------------------------------------------------    --------     ---------      ---------
      Total operating expenses                              57,461        61,828         46,387
- ------------------------------------------------------    --------     ---------      ---------
      Operating loss                                        (1,225)      (17,843)       (18,695)

Interest income                                              1,242         2,234          2,596
Gain (loss) on sales of marketable securities                   64           (51)           242
- ------------------------------------------------------    --------     ---------      ---------
      Income (loss) before income taxes                         81       (15,660)       (15,857)

Income tax benefit                                               0             0          2,101
- ------------------------------------------------------    --------     ---------      ---------
      Net income (loss)                                   $     81     $ (15,660)     $ (13,756)
======================================================    ========     =========      =========
Basic net income (loss) per share                         $    .01     $   (1.09)     $    (.89)
======================================================    ========     =========      =========
Weighted average number of common shares outstanding        14,131        14,372         15,435
======================================================    ========     =========      =========
Diluted net income (loss) per share                       $    .01     $   (1.09)     $    (.89)
======================================================    ========     =========      =========
Weighted average number of common
 and assumed conversion shares outstanding                  14,431        14,372         15,435
======================================================    ========     =========      =========

The accompanying notes are an integral part of the consolidated financial statements.

F-2

CNS, INC.
Consolidated Balance Sheets
December 31, 2001 and 2000
(in thousands, except per share amounts)


                                   Assets                                        2001           2000
- --------------------------------------------------------------------------------------------------------
Current assets:
 Cash and cash equivalents                                                      $   8,311      $   2,079
 Marketable securities                                                             18,984         29,244
 Accounts receivable, net of allowance for doubtful accounts
  of $500 in 2001 and $300 in 2000                                                 12,307         12,582
 Inventories                                                                        5,822          4,752
 Prepaid expenses and other current assets                                          1,294          3,257
- -----------------------------------------------------------------------------   ---------      ---------
      Total current assets                                                         46,718         51,914
Property and equipment, net                                                         2,631          3,201
Product rights, net                                                                 1,269          1,229
- -----------------------------------------------------------------------------   ---------      ---------
                                                                                $  50,618      $  56,344
=============================================================================   =========      =========

                     Liabilities and Stockholders’ Equity
- --------------------------------------------------------------------------------------------------------
Current liabilities:
 Accounts payable                                                               $   6,699      $  12,600
 Accrued expenses                                                                   6,751          6,251
 Accrued income taxes                                                                 556            556
- -----------------------------------------------------------------------------   ---------      ---------
      Total current liabilities                                                    14,006         19,407
Stockholders’ equity:
 Preferred stock -- authorized 8,484 shares;
  none issued or outstanding                                                            0              0
 Common stock -- $.01 par value; authorized 50,000 shares;
  issued 19,295 shares in 2001 and 2000                                               193            193
 Additional paid-in capital                                                        60,785         61,182
 Treasury shares -- at cost; 5,294 shares in 2001 and 5,179 shares in 2000        (23,550)       (23,279)
 Retained deficit                                                                  (1,178)        (1,259)
 Accumulated other comprehensive income                                               362            100
- -----------------------------------------------------------------------------   ---------      ---------
      Total stockholders’ equity                                                   36,612         36,937
Commitments (notes 9 and 10)
- -----------------------------------------------------------------------------   ---------      ---------
                                                                                $  50,618      $  56,344
=============================================================================   =========      =========

The accompanying notes are an integral part of the consolidated financial statements.

F-3

CNS, INC.
Consolidated Statements of Stockholders’Equity and Comprehensive Income (Loss)
Years ended December 31, 2001, 2000 and 1999
(in thousands)


                                        Common Stock                  Treasury Shares                         Accumulated
                                    -------------------  Additional  -------------------------    Retained       Other           Total
                                       Number     Par      Paid-in      Number                    Earnings   Comprehensive   Stockholders’
                                     of Shares   Value     Capital    of Shares       Cost       (Deficit)   Income (Loss)      Equity
- ------------------------------------------------------------------------------------------------------------------------------------------

Balance at December 31, 1998           19,295    $193     $61,933       2,692      $ (14,670)    $  28,157      $   253       $   75,866
 Stock issued in connection with
  Employee Stock Purchase Plan              0       0         (98)        (18)           151             0            0               53
 Stock options exercised                    0       0        (414)       (108)           860             0            0              446
 Warrants issued                            0       0         110           0              0             0            0              110
 Treasury shares purchased                  0       0           0       2,272         (8,562)            0            0           (8,562)
 Comprehensive loss:
   Net loss for the year                    0       0           0           0              0       (13,756)           0          (13,756)
   Unrealized losses on marketable
    securities net of income tax
    effect of $154                          0       0           0           0              0             0         (573)            (573)
                                                                                                                              ----------
     Total comprehensive loss                                                                                                    (14,329)
- ------------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999           19,295     193      61,531       4,838        (22,221)       14,401         (320)          53,584
 Stock issued in connection with
  Employee Stock Purchase Plan              0       0        (131)        (26)           214             0            0               83
 Stock options exercised                    0       0        (218)        (29)           238             0            0               20
 Treasury shares purchased                  0       0           0         396         (1,510)            0            0           (1,510)
 Comprehensive loss:
   Net loss for the year                    0       0           0           0              0       (15,660)           0          (15,660)
   Unrealized gains on marketable
    securities net of income tax
    effect of $0                            0       0           0           0              0             0          420              420
                                                                                                                              ----------
     Total comprehensive loss                                                                                                    (15,240)
- ------------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000           19,295     193      61,182       5,179        (23,279)       (1,259)         100           36,937
 Stock issued in connection with
  Employee Stock Purchase Plan              0       0        (189)        (36)           303             0            0              114
 Stock options exercised                    0       0        (262)        (51)           436             0            0              174
 Other                                      0       0          54           0              0             0            0               54
 Treasury shares purchased                  0       0           0         202         (1,010)            0            0           (1,010)
 Comprehensive income:
   Net income for the year                  0       0           0           0              0            81            0               81
   Unrealized gains on marketable
    securities net of income tax
    effect of $0                            0       0           0           0              0             0          262              262
                                                                                                                              ----------
     Total comprehensive income                                                                                                      343
- ------------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001           19,295    $193     $60,785       5,294      $ (23,550)    $  (1,178)     $   362       $   36,612
========================================================================================================================================

The accompanying notes are an integral part of the consolidated financial statements.

F-4

CNS, INC.
Consolidated Statements of Cash Flows
Years ended December 31, 2001, 2000 and 1999
(in thousands)


                                                               2001           2000            1999
- ----------------------------------------------------------------------------------------------------

Operating activities:
 Net income (loss)                                          $      81      $ (15,660)      $ (13,756)
 Adjustments to reconcile net income (loss) to net cash
  used in operating activities:
   Depreciation and amortization                                1,244          1,051           1,029
   Deferred income taxes                                            0              0           1,486
   Other                                                           90             81             110
   Changes in operating assets and liabilities:
    Accounts receivable                                           275         (1,212)         (3,579)
    Inventories                                                (1,070)           153           3,918
    Prepaid expenses and other current assets                   1,964          3,546          (4,009)
    Accounts payable and accrued expenses                      (5,401)         7,654           2,655
- --------------------------------------------------------    ---------      ---------       ---------
      Net cash used in operating activities                    (2,817)        (4,387)        (12,146)
- --------------------------------------------------------    ---------      ---------       ---------
Investing activities:
 Purchases of marketable securities                           (44,911)       (63,151)        (97,157)
 Sales and maturities of marketable securities                 55,433         72,324         118,230
 Payments for purchases of property and equipment                (394)        (2,019)           (330)
 Payments for product rights                                     (357)          (141)           (259)
- --------------------------------------------------------    ---------      ---------       ---------
      Net cash provided by investing activities                 9,771          7,013          20,484
- --------------------------------------------------------    ---------      ---------       ---------
Financing activities:
 Proceeds from the issuance of common stock under
  Employee Stock Purchase Plan                                    114             83              53
 Proceeds from the exercise of stock options                      174             20             446
 Purchase of treasury shares                                   (1,010)        (1,510)         (8,562)
- --------------------------------------------------------    ---------      ---------       ---------
      Net cash used in financing activities                      (722)        (1,407)         (8,063)
- --------------------------------------------------------    ---------      ---------       ---------
      Net increase in cash and cash equivalents                 6,232          1,219             275
Cash and cash equivalents:
 Beginning of year                                              2,079            860             585
- --------------------------------------------------------    ---------      ---------       ---------
 End of year                                                $   8,311      $   2,079       $     860
========================================================    =========      =========       =========
Supplemental disclosure of cash flow information:
 Cash paid during the year for interest                     $       0      $       0       $       0
 Cash paid during the year for income taxes                         0              0             344
========================================================    =========      =========       =========

The accompanying notes are an integral part of the consolidated financial statements.

F-5

CNS, INC.
Notes to Consolidated Financial Statements
December 31, 2001, 2000 and 1999

(1) Summary of Significant Accounting Policies

Business The Company designs, manufactures and markets consumer products, including Breathe Right® nasal strips and FiberChoice® tablets. The Company’s products are sold over-the-counter in retail outlets, including mass merchant, drug, grocery and club stores. The Company primarily uses international distributors to market Breathe Right nasal strips outside the U.S.

Principles of Consolidation The accompanying consolidated financial statements include the accounts of CNS, Inc. and its subsidiaries (“the Company”). All material intercompany accounts and transactions have been eliminated in consolidation.

Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

Basis of Presentation Certain amounts from prior years’ financial statements have been reclassified to conform to the current year presentation. These reclassifications had no impact on the operating loss or net loss for 2000 and 1999.

Revenue Recognition Revenue from sales is recognized at the time products are shipped less estimated sales returns and other allowances.

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. Inventory reserves have been established for potential product obsolescence.

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.

F-6

Stock Based Compensation The Company follows the disclosure requirements for employee stock based compensation plans and, accordingly, no compensation expense has been recognized.

Foreign Currency Transactions Most foreign transactions are in U.S. dollars, although some are conducted in functional local currencies. The functional currency is translated into U.S. dollars for the balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the fiscal year. Gains and losses resulting from transactions denominated in foreign currencies are included in the consolidated statements of operations.

Advertising The Company capitalizes the production costs of advertising and expenses these costs 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 Basic net income (loss) per share and diluted net income (loss) per share have been computed based upon the weighted average number of common shares outstanding during the year. Assumed conversion shares were excluded from the net loss per share computation as their effect is antidilutive. Common stock options could potentially dilute basic earnings per share in future periods if the Company generates net income. Diluted net income per share has been computed based upon the weighted average number of common and assumed conversion shares outstanding during the year.

Comprehensive Income (Loss) Comprehensive income (loss) consists of the Company’s net income (loss) and unrealized gains (losses) on marketable securities and is presented in the consolidated statements of stockholders’ equity and comprehensive income (loss).

New Accounting Standards In 2000, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-14, “Accounting for Certain Sales Incentives”. This EITF requires companies to present in their statements of operations, certain sales incentives as sales allowances, resulting in a reduction of net sales. The Company currently records sales incentives covered by this EITF as operating expenses. The Company will be required to adopt this EITF beginning with the quarter ending March 31, 2002. If the Company would have applied the presentation set forth in this issue in 2001, 2000 and 1999, net sales would have been reduced by $1,123,000, $1,527,000 and $3,126,000, respectively. Operating expenses would have also been reduced by the same amounts in the corresponding years. This issue does not impact operating income (loss) for any of these years.

In 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

F-7

This statement supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”. The statement retains the previously existing accounting requirements related to the recognition and measurement of the impairment of long-lived assets to be held and used while expanding the measurement requirements of long-lived assets to be disposed of by sale. It also expands the previously existing reporting requirements for discontinued operations to include a component of an entity that either has been disposed of or is classified as held for sale. The Company is required to implement SFAS No. 144 beginning with the quarter ending March 31, 2002. Management does not expect this statement to have a material impact on the Company’s consolidated financial position or results of operations.

(2) Marketable Securities

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


                                                     December 31,
                                 ----------------------------------------------------
                                           2001                        2000
                                 -------------------------   ------------------------
                                    Cost       Fair Value       Cost       Fair Value
                                 ----------   ------------   ----------   -----------

Cash equivalents                  $  1,419      $  1,419      $  2,166     $  2,166
Corporate bonds                     12,544        12,879        24,308       24,413
U.S. Government obligations          4,659         4,686         2,670        2,665
- ------------------------------    --------      --------      --------     --------
 Total marketable securities      $ 18,622      $ 18,984      $ 29,144     $ 29,244
==============================    ========      ========      ========     ========

Maturities of marketable securities at December 31, 2001 are as follows (in thousands):


                                              Cost       Fair Value
                                           -----------   -----------

Due within one year                         $ 10,711      $ 10,847
Due after one year through three years         7,911         8,137
- ----------------------------------------    --------      --------
 Total marketable securities                $ 18,622      $ 18,984
========================================    ========      ========

There were realized gains of $64,000 and $243,000 during 2001 and 1999, respectively and realized losses of $51,000 during 2000.

(3) Advertising

At December 31, 2001 and 2000, $540,000 and $1,924,000, respectively, of advertising costs were reported as assets. Advertising expense was $19,486,000 in 2001, $26,027,000 in 2000, and $11,728,000 in 1999.

F-8

(4) Details of Selected Balance Sheet Accounts

Details of selected balance sheet accounts are as follows (in thousands):


                                            2001       2000       1999
                                          --------   --------   --------

Allowance for doubtful accounts:
 Balance beginning of year                 $ 300      $ 280      $ 210
 Plus provision for doubtful accounts        316         26         96
 Less charge offs                            116          6         26
- ---------------------------------------    -----      -----      -----
  Balance end of year                      $ 500      $ 300      $ 280
=======================================    =====      =====      =====

                                                    December 31
                                              -----------------------
                                                 2001         2000
                                              ----------   ----------
Inventories:
 Finished goods                                $ 3,421      $ 2,139
 Raw materials and component parts               2,401        2,613
- -------------------------------------------    -------      -------
  Total inventories                            $ 5,822      $ 4,752
===========================================    =======      =======
Property and equipment:
 Warehouse and production equipment            $   760      $   556
 Office equipment and information systems        3,642        3,623
 Leasehold improvements                          1,050        1,022
- -------------------------------------------    -------      -------
                                                 5,452        5,201
 Less accumulated depreciation                   2,821        2,000
- -------------------------------------------    -------      -------
  Property and equipment, net                  $ 2,631      $ 3,201
===========================================    =======      =======
Product rights:
 Product rights                                $ 2,905      $ 2,548
 Less accumulated amortization                   1,636        1,319
- -------------------------------------------    -------      -------
  Product rights, net                          $ 1,269      $ 1,229
===========================================    =======      =======
Accrued expenses:
 Promotions and allowances                     $ 3,511      $ 3,085
 Royalties and commissions                       1,276          954
 Salaries, incentives and paid time off          1,501        2,000
 Restructuring costs                               322            0
 Other                                             141          212
- -------------------------------------------    -------      -------
  Total accrued expenses                       $ 6,751      $ 6,251
===========================================    =======      =======

F-9

(5) 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 3,650,000 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 options 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, 2001.

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, 1998          $   4.74          1,580,500         370,650
 Granted                                  3.05            353,000        (353,000)
 Exercised                                4.16           (115,010)              0
 Canceled                                 4.00            (47,100)         47,100
- ------------------------------        --------          ---------        --------
Balance at December 31, 1999              4.47          1,771,390          64,750
 New 2000 Plan                                                  0         700,000
 Granted                                  4.01            358,400        (358,400)
 Exercised                                4.18            (69,690)              0
 Canceled                                 5.18           (168,100)        168,100
- ------------------------------        --------          ---------        --------
Balance at December 31, 2000              4.33          1,892,000         574,450
 Granted                                  4.26            345,960        (345,960)
 Exercised                                3.36            (51,800)
 Canceled                                 4.47           (102,970)        102,970
 Expired                                                        0          (7,280)
- ------------------------------                          ---------        --------
Balance at December 31, 2001          $   4.33          2,083,190         324,180
==============================        ========          =========        ========

Information on outstanding and currently exercisable options by price range as of December 31, 2001, is summarized as follows:


                                      Weighted       Weighted                      Weighted
                        Total         -Average       -Average     Exercisable      -Average
    Price Range       Number of       Remaining      Exercise      Number of       Exercise
     Per Share          Shares      Life (Years)       Price         Shares         Price
- ------------------   -----------   --------------   ----------   -------------   -----------

$2.31 -- 2.81           242,500    6.9               $   2.78        171,000      $   2.77
 3.10 -- 4.00           699,560    5.6                   3.56        445,320          3.38
 4.13 -- 5.00           580,680    7.9                   4.52        264,800          4.69
 5.44 -- 5.94           466,700    4.2                   5.49        434,700          5.49
   7.25                  93,750    5.6                   7.25         93,750          7.25
                        -------                                      -------
                      2,083,190                                    1,409,570
                      =========                                    =========

At December 31, 2001, the weighted-average remaining contractual life of outstanding options was 6.1 years. At December 31, 2001, 2000 and 1999, currently exercisable options aggregated 1,409,570, 1,207,232 and 1,091,156 shares of common stock, respectively and the weighted-average exercise price of those options was $4.46, $4.55 and $4.73, respectively.

The per share weighted-average fair value of stock options granted during 2001, 2000 and 1999 is estimated as $2.55, $2.60 and $1.98, respectively on the date of grant using the Black-Scholes

F-10

option pricing model with the following assumptions: volatility of 60% in 2001 and 65% in 2000 and 1999; risk-free interest rate of 5.00% in 2001, 6.50% in 2000 and 6.00% in 1999, 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 stock compensation 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 $950,000, or $.07 per share in 2001, $900,000, or $.06 per share in 2000 and $950,000, or $.06 per share in 1999.

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 400,000 shares under the plan of which employees as of December 31, 2001 have purchased 224,367 shares.

Warrants In connection with agreements to license certain intellectual property rights to potential products, licensers were issued warrants. During 1999, warrants were issued to purchase 50,000 shares of the Company’s common stock exercisable at a price of $3.44 per share exercisable evenly over three years and for a period of 10 years. The issuance of the warrants resulted in an expense of $110,000. Warrants were issued during 1997 to purchase 25,000 shares at a price of $8.00 per share exercisable in 2000 and for a period of five years. Of these warrants, 48,000 shares are currently exercisable.

Preferred Stock At December 31, 2001, 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 is authorized to issue up to an additional 7,483,589 shares of undesignated preferred stock.

F-11

(6) Income Taxes

Income tax expense (benefit) for the three years ended December 31, 2001, is as follows (in thousands):



                                      Current       Deferred        Total
                                   -------------   ----------   ------------

2001:
 Federal                             $       0      $     0      $       0
 State                                       0            0              0
- --------------------------------     ---------      -------      ---------
  Income tax expense                 $       0      $     0      $       0
================================     =========      =======      =========
2000:
 Federal                             $       0      $     0      $       0
 State                                       0            0              0
- --------------------------------     ---------      -------      ---------
  Income tax expense                 $       0      $     0      $       0
================================     =========      =======      =========
1999:
 Federal                             $  (3,917)     $ 1,816      $  (2,101)
 State                                       0            0              0
- --------------------------------     ---------      -------      ---------
  Income tax expense (benefit)       $  (3,917)     $ 1,816      $  (2,101)
================================     =========      =======      =========

F-12

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


                                                 2001          2000            1999
                                               --------   -------------   -------------

Computed tax expense (benefit)                  $  28       $  (5,481)      $  (5,550)
State taxes, net of federal benefit                 0            (554)           (431)
Tax exempt interest                                 0               0            (178)
Change in deferred tax valuation allowance        (46)          6,018           3,932
Other                                              18              17             126
- --------------------------------------------    -----       ---------       ---------
 Actual tax expense (benefit)                   $   0       $       0       $  (2,101)
============================================    =====       =========       =========

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities for 2001 and 2000 are presented below (in thousands):


                                                      December 31
                                                 ---------------------
                                                   2001        2000
                                                 --------   ----------

Deferred tax assets:
 Inventory items                                  $  339     $   795
 Accounts receivable allowance                       185         111
 Product rights                                      304         246
 Accrued expenses                                  2,109       1,580
 Net operating loss and credit carryforwards       6,654       7,445
- ----------------------------------------------    ------     -------
                                                   9,591      10,177
Less valuation allowance                           9,273       9,950
- ----------------------------------------------    ------     -------
                                                     318         227
                                                  ------     -------
Deferred tax liabilities:
 Unrealized gains on marketable securities          (134)        (35)
 Property and equipment                             (184)       (192)
- ----------------------------------------------    ------     -------
                                                    (318)       (227)
                                                  ------     -------
  Net deferred tax assets                         $    0     $     0
==============================================    ======     =======

In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based on the level of historical taxable income and projections of future taxable income over the periods in which the deferred tax assets are deductible, management does not believe that it is more likely than not the Company will realize the benefits of these deductible differences. Accordingly, the Company has provided a valuation allowance against the net deferred assets as of December 31, 2001.

As of December 31, 2001, the Company has reported federal net operating loss carryforwards of approximately $17,000,000. The federal net operating loss carryforwards expire in 2019 and 2020. Additionally, the Company has a federal credit carryforward for alternative minimum tax of approximately $327,000 that has no expiration date.

F-13

(7) Sales

The Company had one significant customer who accounted for approximately 21%, 19% and 24% of net sales in 2001, 2000 and 1999, respectively. Accounts receivable from this customer as of December 31, 2001 and 2000 were $2,413,000 and $2,274,000, respectively.

Net sales by geographic area are as follows (in thousands):


                      2001          2000          1999
                  -----------   -----------   -----------

Domestic           $ 67,712      $ 62,735      $ 45,062
International        16,222         6,157           988
- ---------------    --------      --------      --------
  Net sales        $ 83,934      $ 68,892      $ 46,050
===============    ========      ========      ========

(8) Special Charges

On June 26, 2001, the Company announced a plan to streamline and realign the Company’s resources to better match its strategic goals. The Company recorded a special charge of $930,000 for costs associated with this restructure plan. Approximately 20 jobs, or 25% of the workforce from throughout the Company, were eliminated. These cost-cutting actions are expected to result in annualized savings of approximately $2 to $2.5 million. Cost savings relating to this plan were realized beginning in July of 2001. During 2001, the Company utilized $608,000 of the $930,000 accrual, primarily for severance benefits. The remaining accrual of $322,000 will be utilized during 2002, primarily for severance benefits.

On September 30, 1999, the Company and the 3M Company (“3M”) amended an exclusive international distribution agreement in a manner that allowed the Company to regain control of the marketing, sales and distribution of Breathe Right nasal strips in international markets. In exchange for a one-time contract termination fee of $6,345,000 paid in 1999, the international distribution agreement with 3M terminated on June 30, 2000.

(9) License Agreements

The Company has agreements to exclusively license intellectual property rights to certain products. Royalties due under these agreements are based on various percentages of net sales. To maintain the Company’s licenses, it must make minimum royalty payments of $1,070,000 each year until patents for the products expire. Royalty expense was approximately $3,524,000 in 2001, $2,692,000 in 2000, and $1,477,000 in 1999.

F-14

(10) Operating Leases

The Company leases equipment and office space under noncancelable operating leases that have initial or noncancelable lease terms in excess of one year. Future minimum lease payments due in accordance with these leases as of December 31, 2001 are as follows (in thousands):



Year Ending December 31,              Amount
- ---------------------------------   ----------

2002                                 $   733
2003                                     744
2004                                     727
2005                                     740
2006                                     755
Later years                            3,104
- ---------------------------------    -------
  Future minimum lease payments      $ 6,803
=================================    =======

Total rental expense for operating leases was $789,000 in 2001, $559,000 in 2000 and $555,000 in 1999.

(11) Net Income (Loss) Per Share

A reconciliation of basic and diluted weighted average common shares outstanding is as follows (in thousands):


                                                   2001       2000        1999
                                                 --------   --------   ---------

Weighted average common shares outstanding        14,131     14,372     15,435
Assumed conversion of stock options                  300          0          0
- ----------------------------------------------    ------     ------     ------
Average common and assumed conversion shares      14,431     14,372     15,435
==============================================    ======     ======     ======

Options and warrants to purchase 722,000 shares of common stock with a range of exercise prices from $5.00 to $8.00 per share were outstanding as of December 31, 2001 but were not included in the computation of diluted earnings per share because the exercise price was greater than the average market price of the common shares. The options expire from 2002 to 2011.

F-15

EX-3.1 3 cns021471_ex3-1.txt AMENDED AND RESTATED BY-LAWS Exhibit 3.1 AMENDED AND RESTATED BY-LAWS OF CNS, INC. DATED JANUARY 23, 2002 CONTENTS OF AMENDED AND RESTATED BY-LAWS OF CNS, INC. ARTICLE 1 - OFFICES............................................................1 1.1) Registered Offices...........................................1 1.2) Offices......................................................1 ARTICLE 2 - CORPORATE SEAL.....................................................1 ARTICLE 3 - SHAREHOLDERS.......................................................1 3.1) Regular Meeting..............................................1 3.2) Special Meetings.............................................2 3.3) Quorum.......................................................2 3.4) Voting.......................................................2 3.5) Notice of Meeting............................................3 3.6) Proxies......................................................3 3.7) Closing Transfer Books.......................................3 3.8) Record Date..................................................3 3.9) Presiding Officer............................................3 3.10) Conduct of Meetings of Shareholders..........................4 3.11) Order of Business............................................4 3.12) Inspectors of Election.......................................5 3.13) Informal Action by Shareholders..............................5 ARTICLE 4 - DIRECTORS..........................................................5 4.1) General Powers...............................................5 4.2) Number.......................................................5 4.3) Qualifications and Term of Office............................5 4.4) Quorum.......................................................5 4.5) Regular Meetings.............................................6 4.6) Telephonic Meetings..........................................6 4.7) Special Meetings.............................................6 4.8) Compensation.................................................6 4.9) Salaries.....................................................6 4.10) Committees...................................................6 4.11) Committee of Disinterested Persons...........................7 4.12) Vacancies....................................................7 4.13) Order of Business............................................7 4.14) Written Consent or Opposition in Advance of Meeting..........7 4.15) Informal Action by Directors.................................8 4.16) Nominations for Election of Directors........................8 ARTICLE 5 - OFFICERS...........................................................8 5.1) Number.......................................................8 5.2) Election, Term of Office and Qualifications..................8 5.3) Chairman of the Board........................................9 5.4) President and Chief Executive Officer........................9 5.5) Chief Operating Officer......................................9 5.6) Vice President...............................................9 5.7) Secretary....................................................9 5.8) Treasurer and Chief Financial Officer........................9 5.9) Assistant Officers..........................................10 5.10) Officers Shall Not Lend Corporate Credit....................10 ARTICLE 6 - INDEMNIFICATION...................................................10 ARTICLE 7 - SHARES AND THEIR TRANSFER.........................................10 7.1) Certificates of Stock.......................................10 7.2) Facsimile Signature.........................................10 7.3) Issuance of Shares..........................................11 7.4) Transfer of Shares..........................................11 7.5) Lost Certificates...........................................11 7.6) Treasury Stock..............................................11 7.7) Indebtedness of Shareholders................................11 7.8) Transfer Agent and Registrar................................11 ARTICLE 8 - BOOKS AND RECORDS.................................................11 8.1) Share Register; Dates of Issuance...........................11 8.2) Other Documents Required....................................12 8.3) Financial Records...........................................12 8.4) Right to Inspect............................................12 8.5) Cost of Copies..............................................12 8.6) Computerized Records........................................13 8.7) Financial Statements........................................13 ARTICLE 9 - DISTRIBUTIONS.....................................................13 9.1) Distributions...............................................13 9.2) Record Date.................................................13 9.3) Restrictions................................................14 ARTICLE 10 - FINANCIAL AND PROPERTY MANAGEMENT................................14 10.1) Fiscal Year.................................................14 10.2) Audit of Books and Accounts.................................14 10.3) Contracts...................................................14 10.4) Checks......................................................14 10.5) Deposits....................................................14 10.6) Voting Securities Held by Corporation.......................14 ARTICLE 11 - WAIVER OF NOTICE.................................................15 ARTICLE 12 - AMENDMENTS.......................................................15 AMENDED AND RESTATED BY-LAWS OF CNS, INC. ARTICLE 1 OFFICES 1.1) Registered Offices - The address of the registered office of the corporation shall be established and maintained at the office of the Corporation Trust Center, 1209 Orange Street, in the City of Wilmington, County of New Castle, State of Delaware and the Corporation Trust Company shall be the registered agent of the corporation. The Board of Directors shall have authority to change the registered office of the corporation from time to time, and any such change shall be registered by the secretary with the Secretary of State of Delaware. 1.2) Offices - The corporation may have such other offices, including its principal business office, either within or without the State of Delaware, as the Board of Directors may designate or as the business of the corporation may require from time to time. ARTICLE 2 CORPORATE SEAL The corporate seal shall have thereon the name of the corporation, and the words "Corporate Seal" and when so directed by the Board of Directors a duplicate of the seal may be kept and used by the secretary or treasurer or by an assistant secretary or assistant treasurer. ARTICLE 3 SHAREHOLDERS 3.1) Regular Meeting - The regular meeting of the shareholders of the corporation shall be an annual meeting held at the principal business office of the corporation, or at such place as is designated by the Board of Directors or by written consent of all the shareholders entitled to vote thereat, at which time the shareholders, voting as provided in the Articles of Incorporation, shall elect a Board of Directors for the ensuing year, and shall transact such other business as shall properly come before them. In the event the regular meeting is not held for a period of thirteen (13) months or more, a shareholder or director may apply to the Court of Chancery to summarily order a meeting to be held. To be properly brought before the annual meeting, business must be of a nature that is appropriate for consideration at an annual meeting and must be (i) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (ii) otherwise properly brought before the meeting by a shareholder. In addition to any other applicable requirements, for business to be properly brought before the annual meeting by a 1 shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of the corporation. To be timely, each such notice must be given, either by personal delivery or by United States mail, postage prepaid, to the Secretary of the corporation, not less than 45 days nor more than 60 days prior to the date the proxy materials for the previous year's annual meeting were mailed to shareholders of the corporation. Each such notice to the Secretary shall set forth as to each matter the shareholder proposes to bring before the annual meeting (w) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (x) the name and address of record of the shareholders proposing such business, (y) the class or series (if any) and the number of shares of the corporation which are owned by the shareholder, and (z) any material interest of the shareholder in such business. Notwithstanding anything in these By-laws to the contrary, no business shall be transacted at the annual meeting except in accordance with the procedures set forth in this Article; provided, however, that nothing in this Article shall be deemed to preclude discussion by any shareholder of any business properly brought before the annual meeting, in accordance with these By-Laws. 3.2) Special Meetings - Special meetings of the shareholders shall be called by the Secretary at any time upon request of the President, a Vice-President acting in the capacity of the President, the Treasurer or two (2) or more members of the Board of Directors, or upon a written request of shareholders holding ten percent (10%) or more of the capital stock entitled to vote. Notice shall be given in accordance with the provisions of Article 3.5 hereof. 3.3) Quorum - The holders of fifty (50%) percent of the outstanding shares entitled to vote, represented either in person or by proxy, shall constitute a quorum for the transaction of business. The shareholders present at a duly called or held meeting, at which a quorum of the shareholders is present, may continue to transact business until adjournment notwithstanding the withdrawal of enough shareholders to leave less than a quorum. In case a quorum is not present at any meeting, those present shall have the power to adjourn the meeting from time to time, without notice or other announcement at the meeting, until the requisite number of voting shares shall be represented. Any business may be transacted at such reconvened meeting which might have been transacted at the meeting which was adjourned. 3.4) Voting - At each meeting of the shareholders, every shareholder having the right to vote shall be entitled to vote in person or by proxy duly appointed by an instrument in writing subscribed by such shareholder. Each shareholder shall have one (1) vote for each share having voting power standing in his name on the books of the corporation. Shares owned by two (2) or more shareholders may be voted by any one of them unless the corporation receives written notice from any one of them denying the authority of that person to vote those shares. A holder of voting shares may vote any portion of the shares in any way the shareholder chooses. If a shareholder votes without designating the proportion or number of shares voted in a particular way, the shareholder is deemed to have voted all the shares in that way. Upon the demand of any shareholder, the vote for director, or the vote upon any question before the meeting shall be by ballot. All elections shall be had and all questions decided by a majority vote of the number of shares entitled to vote and represented at any meeting at which there is a quorum, except in such cases as shall otherwise be required or permitted by statute, the Certificate of Incorporation, these By-Laws or by agreement approved by a majority vote of the number of shares entitled to vote. 2 3.5) Notice of Meeting - There shall be mailed to each shareholder shown by the books of the corporation to be a holder of record of voting shares, at his address as shown by the books of the corporation, a notice setting out the time and place of the regular meeting or any special meeting, which notice shall be mailed at least ten (10) days and not more than sixty (60) days prior thereto. Every notice of any special meeting shall state the purpose or purposes of the proposed meeting, and the business transacted at all special meetings shall be confined to purposes stated in the call. A shareholder may waive notice of a meeting of shareholders. A waiver of notice by a shareholder entitled to notice is effective whether given before, at, or after the meeting, or whether given in writing, orally, or by attendance. Attendance by a shareholder at a meeting is a waiver of notice of that meeting, except where the shareholder objects at the beginning of the meeting to the transaction of business because the meeting is not lawfully called or convened, or objects before a vote on an item of business because the item may not lawfully be considered at that meeting and does not participate in the consideration of the item at that meeting. 3.6) Proxies - At all meetings of shareholders, a shareholder may vote by proxy executed in writing by the shareholder or by his duly authorized attorney-in-fact. Such proxies shall be filed with the Secretary of the corporation before or at the time of the meeting. No proxy shall be valid after eleven (11) months from the date of its execution, unless otherwise provided in the proxy. No appointment of a proxy is irrevocable unless the appointment is coupled with an interest in the shares of the corporation. 3.7) Closing Transfer Books - The Board of Directors may close the stock transfer books for a period of time not exceeding sixty (60) days preceding the date of any meeting of shareholders, payment of dividend, allotment of rights, change, conversion or exchange of capital stock or the date of obtaining consent of shareholders for any purpose. 3.8) Record Date - In lieu of closing the stock record books the Board of Directors may fix in advance a date, not exceeding sixty (60) days preceding the date of any of the aforesaid events, as a record date for the determination of shareholders entitled to notice of and to vote at any such meeting and any adjournment thereof, or to receive any such dividend or allotment or rights, or to exercise the rights in respect to any change, conversion or exchange of capital stock or to give such consent, and in such case only such shareholders on the record date so fixed shall be entitled to notice of and to vote at such meeting and any adjournment thereof, or to receive such dividend or allotment of rights, or to exercise such rights, or to give such consent, as the case may be, notwithstanding any transfer of any stock on the books of the corporation after any such record date so fixed. If the stock transfer books are not closed and no record date is fixed for such determination of the shareholders of record, the date on which notice of the meeting is mailed, or the date of adoption of a resolution of the Board of Directors declaring a dividend, allotment of rights, change, conversion or exchange of capital stock or to give such consent, as the case may be, shall be the record date for such determination of shareholders. A determination of shareholders entitled to vote shall apply to any adjournment of such meeting except when the date of determination or the closing of the stock transfer book exceeds sixty (60) days preceding such adjourned meeting, in which event a new meeting must be called. 3.9) Presiding Officer - The appropriate officers of the corporation shall preside over all meetings of the shareholders; provided, however, that in the absence of an appropriate corporate 3 officer at any meeting of the shareholders, the meeting shall choose any person present to act as presiding officer of the meeting. 3.10) Conduct of Meetings of Shareholders - Subject to the following, meetings of shareholders generally shall follow accepted rules of parliamentary procedure: 1. The chairman of the meeting shall have absolute authority over matters of procedure and there shall be no appeal from the ruling of the chairman. If the chairman, in his absolute discretion, deems it advisable to dispense with the rules of parliamentary procedure as to any one meeting of shareholders or part thereof the chairman shall so state and shall clearly state the rules under which the meeting or appropriate part thereof shall be conducted. 2. If disorder should arise which prevents continuation of the legitimate business of the meeting, the chairman may quit the chair and announce the adjournment of the meeting; and upon his so doing, the meeting is immediately adjourned. 3. The chairman may ask or require that anyone not a bona fide shareholder or proxy leave the meeting. 4. A resolution or motion shall be considered for vote only if proposed by a shareholder or duly authorized proxy, and seconded by an individual who is a shareholder or a duly authorized proxy, other than the individual who proposed the resolution or motion; provided, however, that the chairman shall have the discretion to rule out of order any resolution or motion which seeks shareholder vote on (i) a proposal that has failed to comply with the requirements of Article 3.1, or (ii) any nomination(s) for the election of directors that fails to comply with Article 4.16. 3.11) Order of Business - The suggested order of business at the regular meeting of shareholders, and so far as possible at all other meetings of the shareholders, shall be: 1. Calling of roll. 2. Proof of due notice of meeting, or unanimous waiver. 3. Reading and disposal of any unapproved minutes. 4. Annual reports of all officers and committees. 5. Election of directors. 6. Unfinished business. 7. New business properly presented. 8. Adjournment. 4 3.12) Inspectors of Election - The Board of Directors in advance of any meeting of shareholders may appoint inspectors to act at such meeting or any adjournment thereof. If inspectors of election are not so appointed, the officer or person acting as chairman of any such meeting may, and on the request of any shareholder or his proxy, shall make such appointment. In case any person appointed as inspector shall fail to appear or act, the vacancy may be filled by appointment made by the Board of Directors in advance of the meeting, or at the meeting by the officer or person acting as chairman. The inspectors of election shall determine the number of shares outstanding, the voting power of each, the shares represented at the meeting, the existence of a quorum, the authenticity, validity and effect of proxies, receive votes, ballots, assents or consents, hear and determine all challenges and questions in any way arising and announce the result, and do such acts as may be proper to conduct the election or vote with fairness to all shareholders. No inspector whether appointed by the Board of Directors or by the officer or person acting as chairman need be a shareholder. 3.13) Informal Action by Shareholders - Any action required to be taken at a meeting of the shareholders, or any other action which may be taken at a meeting of the shareholders, may be taken without a meeting and notice thereof if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. The written action is effective when it has been signed by all of those shareholders, unless a different effective time is provided in the written action. ARTICLE 4 DIRECTORS 4.1) General Powers - The property, affairs, and business of the corporation shall be managed by the Board of Directors. 4.2) Number - The Board of Directors shall consist of such number of directors, not less than five (5) nor more than ten (10), the exact number to be fixed from time to time solely by resolution of the Board of Directors, acting by not less than a majority of the directors then in office. 4.3) Qualifications and Term of Office - Directors need not be shareholders or residents of the State of Delaware. Directors shall be elected by the shareholders at the regular meeting for a term of one (1) year or until their successors are elected and qualified. Each of the directors of the corporation shall hold office until the regular meeting next following or closely coinciding with the expiration of his term of office and until his successor shall have been elected and shall qualify or until he shall resign, or shall have been removed as provided by statute. 4.4) Quorum - A majority of the whole Board of Directors shall constitute a quorum for the transaction of business; provided, however, that if any vacancies exist by reason of death, resignation or otherwise, a majority of the remaining directors shall constitute a quorum for the conduct of business. If less than a quorum is present at any meeting, a majority of the directors present may adjourn the meeting from time to time without further notice. If a quorum is present when a duly called or held meeting is convened, the directors present may continue to transact 5 business until adjournment, even though the withdrawal of a number of directors originally present leaves less than a majority. 4.5) Regular Meetings - As soon as practical after each regular meeting of shareholders, the Board of Directors shall meet for the purposes of organization, choosing the officers of the corporation and for the transaction of other business at the place where the shareholders' meeting is held or at the place where regular meetings of the Board of Directors are held. No notice of such meeting need be given. Such first meeting may be held at any other time and place which shall be specified in a notice given as hereinafter provided for special meetings or in a consent and waiver of notice signed by all the directors. 4.6) Telephonic Meetings - Any member or members of the Board of Directors, or any committee designated by such Board, may participate in a meeting of the Board of Directors or such committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this paragraph shall constitute presence in person at such meeting. 4.7) Special Meetings - Special meetings of the Board of Directors may be held at such time and place as may from time to time be designated in the notice or waiver of notice of the meeting. Special meetings of the Board of Directors may be called by the president, or by any director. Unless notice shall be waived by all directors entitled to notice, notice of the special meeting shall be given by the secretary, who shall give at least twenty-four (24) hours notice thereof to each director by mail, telegraph, telephone, or in person; provided, however, that meetings may be held without waiver of notice from or giving notice to any director while he is in the Armed Forces of the United States. Each director, by his attendance and his participation in the action taken at any directors' meeting, shall be deemed to have waived notice of such meeting. 4.8) Compensation - Directors and any members of any committee of the corporation contemplated by these By-Laws or otherwise provided for by resolution of the Board of Directors, shall receive such compensation therefore as may be determined from time to time by resolution of the Board of Directors. Nothing herein contained shall be construed to preclude any director from serving the corporation in any other capacity and receiving proper compensation therefor. 4.9) Salaries - Salaries and other compensation of all officers and employees of the corporation shall be fixed by the Board of Directors. Nothing herein contained shall be construed to preclude any officer from serving the corporation as a director, consultant or in any other capacity and receiving proper compensation therefor. In the event that any authority, such as the Internal Revenue Service, determines, and such determination is ultimately accepted, that any compensation paid to a director, officer or employee of the corporation is excessive and disallows the corporate deduction therefor, the recipient of the amounts so determined to be excessive shall repay the corporation said amount. 4.10) Committees - A resolution approved by the affirmative vote of a majority of the Board of Directors may establish committees having the authority of the Board in the management of the business of the corporation to the extent provided in the resolution. Committees are subject at all times to the direction and control of the Board of Directors except as provided in Article 4.11. A committee shall consist of one or more natural persons, who are directors, appointed by 6 affirmative vote of a majority of the directors present. A majority of the members of the committee present at a meeting is a quorum for the transaction of business unless a larger or smaller proportion is provided in a resolution approved by the affirmative vote of a majority of the directors present. 4.11) Committee of Disinterested Persons - The Board of Directors may establish a committee composed of two or more disinterested directors or other disinterested persons to determine whether it is in the best interests of the corporation to pursue a particular legal right or remedy of the corporation and whether to cause the dismissal or discontinuance of a particular proceeding that seeks to assert a right or remedy on behalf of the corporation. A director or other person is "disinterested" if he is not an owner of more than one percent of the outstanding shares of, or a present or former officer, employee or agent of the corporation or of a related corporation and has not been made or threatened to be made a party to the proceeding in question. The committee, once established, is not subject to the direction or control of, or termination by, the Board of Directors. A vacancy on the committee may be filled by a majority vote of the remaining members. The good faith determinations of the committee are binding upon the corporation and its directors, officers and shareholders. The committee terminates when it issues a written report of its determinations. 4.12) Vacancies - Any vacancy in the Board of Directors shall be filled by an affirmative vote of a majority of the remaining directors of the Board, though less than a quorum, and each person so elected shall be a director until his successor is elected by the shareholders, who may make such election at their next annual meeting or any meeting duly called for that purpose. 4.13) Order of Business - The meetings shall be conducted in accordance with Roberts Rules of Order, Revised, and the suggested order of business at any meeting of the directors shall be: 1. Roll call. 2. Proof of due notice of meeting, or unanimous consent, or unanimous presence and declaration by president. 3. Reading and disposal of any unapproved minutes. 4. Reports of officers and committees. 5. Election of officers. 6. Unfinished business. 7. New business. 8. Adjournment. 4.14) Written Consent or Opposition in Advance of Meeting - Any member of the Board of Directors or a committee thereof, may give advance written consent or opposition to a proposal or resolution stating an action to be taken by the Board or committee. Such consent or opposition shall be a vote in favor of or against the proposal or resolution if the proposal or resolution acted 7 upon at the meeting is substantially the same or has substantially the same effect as the proposal or resolution to which the member of the Board or committee has consented or objected. 4.15) Informal Action by Directors - Any action required or permitted to be taken at a meeting of the directors may be taken without a meeting and notice thereof if a consent in writing, setting forth the action so taken, shall be signed by all of the directors entitled to vote with respect to the subject matter set forth. 4.16) Nominations for Election of Directors - Subject to the rights of holders of any class or series of stock having a preference over the common shares as to dividends or upon liquidation, nominations for the election of directors may be made by the Board of Directors or a committee appointed by the Board of Directors or by any shareholder entitled to vote generally in the election of directors. However, any shareholder entitled to vote generally in the election of directors may nominate one or more persons for election as directors at a meeting only if written notice of such shareholder's intent to make such nomination or nominations has been given, either by personal delivery or by United States mail, postage prepaid, to the Secretary of the corporation not less than 45 days nor more than 60 days prior to the date the proxy materials for the previous year's annual meeting were mailed to shareholders of the corporation. Each such notice to the Secretary shall set forth: (i) the name and address of record of the shareholder who intends to make the nomination; (ii) a representation that the shareholder is a holder of record of shares of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (iii) the name, age, business and residence addresses, and principal occupation or employment of each nominee; (iv) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder; (v) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission; and (vi) the consent of each nominee to serve as a director of the corporation if so elected. The corporation may require any proposed nominee to furnish such other information as may reasonably be required by the corporation to determine the eligibility of such proposed nominee to serve as a director of the corporation. The chairman or presiding officer of the meeting may, if the facts warrant, determine that a nomination was not made in accordance with the foregoing procedure, and if the chair or presiding officer should so determine, he or she shall so declare to the meeting and the defective nomination shall be disregarded. ARTICLE 5 OFFICERS 5.1) Number - The officers of the corporation shall include a president or chief executive officer, a treasurer or chief financial officer and a secretary and may include such other officers as may from time to time be chosen by the Board of Directors. Any two offices except those of president and vice-president may be held by one person. 5.2) Election, Term of Office and Qualifications - At any regular meeting of the Board of Directors, the Board shall elect from their number a president or chief executive officer and shall, from within or without their number, elect a treasurer or chief financial officer and a secretary, and 8 may, in addition, from within or without their number, elect one or more vice-presidents and such other officers and assistant officers as may be deemed advisable. Such officers shall hold office until the next regular meeting or until their successors are elected and qualified; provided, however, that any officer may be removed with or without cause by the affirmative vote of a majority of the whole Board of Directors. 5.3) Chairman of the Board - The chairman of the board of directors shall preside at all meetings of shareholders and directors, and he shall have such other powers and perform such other duties as the Board of Directors may from time to time prescribe. 5.4) President and Chief Executive Officer - The president shall have general and active management of the business under the supervision and direction of the Board of Directors, and he shall be responsible for carrying into effect all orders and resolutions of the Board of Directors. He shall be the chief executive officer of the corporation and shall perform all duties usually incident to the office of president and chief executive officer and such other duties as may be from time to time prescribed by the Board of Directors; except that if the Board of Directors elects a separate chief executive officer, then the president shall perform such duties usually incident to the office of president and the chief executive officer shall perform such duties usually incident to the office of the chief executive officer and each of them shall perform such duties as may be from time to time prescribed to each of them by the Board of Directors. 5.5) Chief Operating Officer - The chief operating officer of the corporation shall be responsible for directing and supervising the corporation's overall business activities. He shall be the officer primarily responsible for planning and carrying out the business policies of the corporation and shall report to the Board of Directors thereon at each meeting of the Board of Directors. He shall have such other responsibilities and shall exercise such additional authority as may from time to time be assigned to him by the Board. 5.6) Vice President - Each vice-president shall have such powers and shall perform such duties as may be specified in these By-Laws or prescribed by the Board of Directors. In the event of absence or disability of the president, a vice-president shall succeed to his powers and duties in the order in which they are elected or as otherwise prescribed by the Board of Directors. A vice- president who is not a director shall not succeed to the office of president. 5.7) Secretary - The secretary shall be secretary of and shall attend all meetings of the shareholders and Board of Directors. He shall act as clerk thereof and shall record all the proceedings of such meetings in the minute book of the corporation. He shall give proper notice of meetings of shareholders and directors. He shall keep the seal of the corporation and shall affix the same to any instrument requiring it and shall attest the seal by his signature. He shall, with the president or any vice-president, acknowledge all certificates for shares of the corporation and shall perform such other duties as may be prescribed from time to time by the Board of Directors. 5.8) Treasurer and Chief Financial Officer - The treasurer shall keep accurate accounts of all moneys of the corporation received or disbursed. He shall deposit all moneys, drafts, and checks in the name and to the credit of the corporation in such banks and depositories as the Board of Directors shall designate from time to time. He shall endorse for deposit all notes, checks and drafts received by the corporation as ordered by the Board of Directors, making proper vouchers therefor. 9 He shall disburse the funds of the corporation as authorized by the Board of Directors. He shall render to the president and the Board of Directors, whenever required, an account of all of his transactions as treasurer and of the financial condition of the corporation and shall perform such other duties as may be prescribed by the Board of Directors from time to time. 5.9) Assistant Officers - In the event of absence or disability of any vice-president, secretary, or treasurer, such assistants to such officers shall succeed to the powers and duties of the absent officer in the order in which they are elected or as otherwise prescribed by the Board of Directors until such principal officer shall resume his duties or a replacement is elected by the Board of Directors. Such assistant officers shall exercise such other powers and duties as may be delegated to them from time to time by the Board of Directors, but they shall be subordinate to the principal officer they are designated to assist. 5.10) Officers Shall Not Lend Corporate Credit - Except for the proper use of the corporation, no officer of this corporation shall sign or endorse in the name or on behalf of this corporation, or in his official capacity, any obligations for the accommodation of any other party or parties, nor shall any check, note, bond, stock certificate or other security or thing of value belonging to this company be used by any officer or director as collateral for any obligation other than valid obligations of this corporation. ARTICLE 6 INDEMNIFICATION Any person who at any time shall serve or shall have served as a director, officer, employee or agent of the Corporation, and the heirs, executors and administrators of such person shall be indemnified by the Corporation in accordance with, and the fullest extent permitted by, the provisions of the Delaware General Corporation Law, as it may be amended from time to time. ARTICLE 7 SHARES AND THEIR TRANSFER 7.1) Certificates of Stock - Every owner of stock of the corporation shall be entitled to a certificate, to be in such form as the Board of Directors prescribe, certifying the number of shares of stock of the corporation owned by him. The certificates for such stock shall be numbered in the order in which they shall be issued and shall be signed in the name of the corporation by the president, and by the secretary, or by any other two (2) proper officers of the corporation authorized by the Board of Directors. A record shall be kept of the name of the person, firm or corporation owning the stock represented by each such certificate, and the respective issue date thereof, and in the case of cancellation, the respective dates of cancellation. Every certificate surrendered to the corporation for exchange or transfer shall be canceled and no other certificate or certificates shall be issued in exchange for any existing certificates until such existing certificate shall have been so canceled except in cases provided for in Article 7.5. 7.2) Facsimile Signature - Where any certificate is manually signed by a transfer agent, a transfer clerk or by a registrar appointed by the Board of Directors to perform such duties, a 10 facsimile or engraved signature of the president and secretary or other proper officer of the corporation authorized by the Board of Directors may be inscribed on the certificate in lieu of the actual signature of such officer. The fact that a certificate bears the facsimile signature of an officer who has ceased to hold office shall not affect the validity of such certificate if otherwise validly issued. 7.3) Issuance of Shares - Subject to the provisions and limitations of Article 4 of the Certificate of Incorporation, the Board of Directors is authorized to cause to be issued shares of the corporation, to the full amount of such authorized shares, and at such times as may be determined by the Board of Directors and as may be permitted by law. 7.4) Transfer of Shares - Transfer of shares on the books of the corporation may be authorized only by the shareholder named in the certificate, or by the shareholder's legal representative, or duly authorized attorney-in-fact, and upon surrender for cancellation of the certificate or certificates for such shares. The shareholder in whose name shares of stock stand on the books of the corporation shall be deemed the owner thereof for all purposes as regards the corporation; provided, that when any transfer of shares shall be made as collateral security, and not absolutely, such facts, if known to the secretary of the corporation, or to the transfer agent, shall be so expressed in the entry of transfer. 7.5) Lost Certificates - Any shareholder claiming a certificate of stock to be lost or destroyed shall make an affidavit or affirmation of that fact in such form as the Board of Directors may require, and shall, if the directors so require, give the corporation a bond of indemnity in form and with one or more sureties satisfactory to the Board, in an amount determined by the Board of Directors not exceeding double the value of the stock represented by such certificate to indemnify the corporation, against any claim that may be made against it on account of the alleged loss or destruction of such certificate; whereupon a new certificate may be issued in the same tenor and for the same number of shares as the one alleged to have been destroyed or lost. 7.6) Treasury Stock - Treasury stock shall be held by the corporation subject to disposal by the Board of Directors, in accordance with the Certificate of Incorporation and these By-Laws, and shall not have voting rights nor participate in dividends. 7.7) Indebtedness of Shareholders - The corporation shall have a first lien on all the shares of its capital stock and upon all dividends declared upon the same for any indebtedness of the respective holders thereof to the corporation. 7.8) Transfer Agent and Registrar - The Board of Directors may appoint one or more transfer agents or transfer clerks, and may require all certificates for shares to bear the signature or signatures of any of them. ARTICLE 8 BOOKS AND RECORDS 8.1) Share Register; Dates of Issuance - The corporation shall keep at its principal business office, or at another place or places within the United States determined by the Board of Directors, 11 a share register not more than one year old, containing the names and addresses of the shareholders and the number and classes of shares held by each shareholder. The corporation shall also keep, with the share register, a record of the dates on which certificates or transaction statements representing shares were issued. 8.2) Other Documents Required - A corporation shall keep at its principal business office, or, if its principal business office is outside of this state, shall make available at its registered office within ten days after receipt by an officer of the corporation of a written demand for them made by a person described in Article 8.4, originals or copies of: 1. Records of all proceedings of shareholders for the last three years; 2. Records of all proceedings of the board for the last three years; 3. Its articles and all amendments currently in effect; 4. Its by-laws and all amendments currently in effect; 5. Financial statements required by Article 8.7 and the financial statement for the most recent interim period prepared in the course of the operation of the corporation for distribution to the shareholders or to a governmental agency as a matter of public record; 6. Reports made to shareholders generally within the last three years; 7. A statement of the names and usual business addresses of its directors and principal officers; 8. Voting trust agreements; and 9. Shareholder control agreements. 8.3) Financial Records - A corporation shall keep appropriate and complete financial records. 8.4) Right to Inspect - A shareholder, beneficial owner, or a holder of a voting trust certificate has an absolute right, upon written demand, to examine and copy, in person or by a legal representative, during the usual hours for business, the share register and all documents referred to in Article 8.2. A shareholder, beneficial owner, or a holder of a voting trust certificate has a right, upon written demand, to examine and copy in person or by legal representative, other corporate records during the usual hours for business, only if the shareholder, beneficial owner, or holder of a voting trust certificate demonstrates a proper purpose for the examination. A "proper purpose" is one reasonably related to the person's interest as a shareholder, beneficial owner, or holder of a voting trust certificate of the corporation. 8.5) Cost of Copies - Copies of all documents referred to in Article 8.2 shall be furnished at the expense of the corporation. A copy of the most recently generated share register shall be 12 furnished at the expense of the corporation if the requesting party shows a proper purpose. In all other cases, the corporation may charge the requesting party a reasonable fee to cover the expenses of providing the copy. 8.6) Computerized Records - The records maintained by the corporation, including its share register, financial records, and minute books, may utilize any information storage technique, including, for example, punched holes, printed or magnetized spots, or microimages, even though that makes them illegible visually, if the records can be converted, by machine and within a reasonable time, into a form that is legible visually and whose contents are assembled by related subject matter to permit convenient use by people in the normal course of business. The corporation shall convert any of the records referred to in Articles 8.1 and 8.2 upon the request of a person entitled to inspect them, and the expense of the conversion shall be borne by the person who bears the expense of copying pursuant to Article 8.5. A copy of the conversion is admissible in evidence, and shall be accepted for all other purposes, to the same extent as the existing or original records would be if they were legible visually. 8.7) Financial Statements - The corporation shall upon written request by a shareholder stating a proper purpose therefor, furnish annual financial statements, including at least a balance sheet as of the end of each fiscal year and a statement of income for the fiscal year, which shall be prepared on the basis of accounting methods reasonable in the circumstances and may be consolidated statements of the corporation and one or more of its subsidiaries. In the case of statements audited by a public accountant, each copy shall be accompanied by a report setting forth the opinion of the accountant on the statements; in other cases, each copy shall be accompanied by a statement of the president or other person in charge of the corporation's financial records stating the reasonable belief of the person that the financial statements were prepared in accordance with accounting methods reasonable in the circumstances, describing the basis of presentation, and describing any respects in which the financial statements were not prepared on a basis consistent with those prepared for the previous year. ARTICLE 9 DISTRIBUTIONS 9.1) Distributions - The Board of Directors may authorize distributions by the corporation from funds legally available therefor at such times and in such amounts as the Board shall deem reasonable. 9.2) Record Date - Subject to any provisions of the Certificate of Incorporation, the Board of Directors may fix a date preceding the date fixed for the payment of any distribution or allotment of other rights as the record date for the determination of the shareholders entitled to receive payment of such distribution or allotment notwithstanding any transfer of shares on the books of the Corporation after such record date. 13 9.3) Restrictions - A distribution may be made to the holders of a class or series of shares only if: 1. All amounts payable to the holders of shares having a preference for the payment of that kind of distribution are paid; and 2. The payment of the distribution does not reduce the remaining net assets of the corporation below the aggregate preferential amount payable in the event of liquidation to the holders of shares having preferential rights, unless the distribution is made to those shareholders in the order and to the extent of their respective priorities. 3. The money or property available for distribution is insufficient to satisfy all preferences, the distributions shall be made pro rate according to the order of priority of preferences by classes and by series within those classes. ARTICLE 10 FINANCIAL AND PROPERTY MANAGEMENT 10.1) Fiscal Year - The fiscal year of the corporation shall be set by the Board of Directors. 10.2) Audit of Books and Accounts - The books and accounts of the corporation shall be audited at such times as may be ordered by the Board of Directors. 10.3) Contracts - The Board of Directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the corporation, and such authority may be general or confined to specific instances. 10.4) Checks - All checks, drafts, or other orders for the payment of money, notes, or other evidences of indebtedness issued in the name of the corporation shall be signed by the treasurer or such other officer or officers, agent or agents of the corporation and in such manner as shall from time to time be determined by resolution of the Board of Directors. 10.5) Deposits - All funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies, or other depositories as the Board of Directors may select. 10.6) Voting Securities Held by Corporation - The president or other agent designated by the Board of Directors, shall have full power and authority on behalf of the corporation to attend, act and vote at any meeting of security holders of other corporations in which this corporation may hold securities. At such meeting the president, or such other agent, shall possess and exercise any and all rights and powers incident to the ownership of such securities which the corporation might possess and exercise. 14 ARTICLE 11 WAIVER OF NOTICE Whenever any notice whatsoever is required to be given by these By-Laws or the Certificate of Incorporation of the corporation or any of the corporate laws of the State of Delaware, a waiver thereof in writing, signed by the person or persons entitled to said notice, either before, at, or after the time stated therein, shall be deemed equivalent thereto. ARTICLE 12 AMENDMENTS Subject to the limitations set forth in the Delaware General Corporation Law, these By-Laws may be amended by a vote of the majority of the whole Board of Directors at any meeting, provided that notice of such proposed amendment shall have been included in the notice of such meeting given to the directors. The undersigned Secretary hereby certifies that the foregoing Amended and Restated By- Laws were adopted as the complete By-Laws of the corporation by the Board of Directors on this 23rd day of January, 2002. /s/ Patrick Delaney ---------------------------------------- Patrick Delaney, Secretary 15 EX-10.9 4 cns021471_ex10-9.txt ADDENDUM TO LICENSE AGREEMENT Exhibit 10.9 CERTAIN INFORMATION HAS BEEN DELETED FROM THIS EXHIBIT AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT UNDER RULE 24B-2. EXECUTION COPY ADDENDUM TO LICENSE AGREEMENT THIS ADDENDUM TO LICENSE AGREEMENT (the "Addendum") is made and effective as of the 25th day of March, 2002 (the "Effective Date"), by and between CNS, Inc., a Delaware corporation ("Licensee"), and WinEase, L.L.C., a Minnesota limited liability company ("Licensor"). R E C I T A L S WHEREAS, Licensor and Licensee are parties to that certain license agreement dated March 12, 1999 (the "License Agreement"); WHEREAS, Licensor granted to Licensee under the License Agreement an exclusive, worldwide, royalty bearing license under all of those Patent Rights, Know-how, Product Improvements and Trademark Rights relating to the development, manufacture, sale and use of the Products and Licensed Methods and other intellectual property rights relating to nasal support devices for animals; WHEREAS, Licensee has been engaged in, among other things, the development, commercialization, production and marketing of the "Products" (as that term is defined in the License Agreement) in accordance with the License Agreement; WHEREAS, Licensee desires to enter into an exclusive and worldwide distribution, marketing and selling relationship for the Products (the "Distribution Relationship") with a recognized distributor known as Merial Limited, a company registered in England and Wales and domesticated in the United States as Merial LLC ("Merial"); WHEREAS, Licensee will be entering into the Distribution Relationship with Merial substantially concurrently with the execution of this Addendum; WHEREAS, Licensee represents that the total expenses that Licensee has incurred to date in connection with the development, commercialization, production and marketing of the Products have exceeded Net Sales by at least [***]; and WHEREAS, Licensor and Licensee desire to address certain issues relating to the rights and relationship of the parties and desire to amend the License Agreement accordingly and further desire to provide for certain other agreements as set forth herein; NOW, THEREFORE, in consideration of these premises, and the mutual covenants and agreements set forth in the License Agreement and hereinafter set forth and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: A. Amendments to License Agreement. The License Agreement is hereby amended as follows: 1. General Definitions. Paragraph 1 is hereby amended to add the following after Paragraph 1.9: "1.10 Other Definitions. The terms "Acquirer," "Affiliate," "Effective Date," "Excess Amount," "Proceeds," "Recoupment Amount," "Transfer," "Third-Party Transferee" and any other terms not defined in this Paragraph 1 shall have the meanings ascribed to the terms elsewhere in this Agreement." 2. Assignments. Paragraph 2.4 of the License Agreement is hereby amended and restated in its entirety to read as follows: "(a) Licensee may sell, assign, convey or transfer any and all of its rights under this Agreement ("Transfer") to a successor in interest of all, or substantially all, of the assets or capital stock of Licensee (the "Acquirer"). In the event of such a Transfer, any such Acquirer shall assume all of the obligations of Licensee hereunder and this Agreement shall be binding upon and inure to the benefit of such Acquirer. No other Transfer may be made by Licensee or Acquirer without complying with subsections (b) and (c) of this Paragraph. (b) Except as otherwise set forth in or contemplated by Paragraph 2.3 above, no other Transfer may be made by Licensee or the Acquirer without Licensor's prior written consent unless Licensee or the Acquirer grants Licensor an exclusive right of first refusal to purchase all of the rights conferred under this Agreement in accordance with the following procedure: (i) First, Licensee shall give Licensor written notification of its intention to enter into a transaction which operates to effectuate a Transfer to a third party that is not an Acquirer ("Third-Party Transferee") and shall not enter into any such transaction without first disclosing all material information about the proposed transaction to Licensor and offering to enter into a transaction on substantially identical terms with Licensor; and then (ii) Second, Licensor shall, unless otherwise waived in writing by Licensor, have a period of thirty (30) days after receipt of written notification provided in accordance with subsection (b)(i) above to exercise its right of first refusal by providing written notice to Licensee 2 and agree to consummate a Transfer on substantially identical terms. The right of first refusal procedure outlined in this Paragraph 2.4 shall be repeated prior to entering into by Licensee of any transaction that is (a) on terms less favorable in a material respect to the Licensee or the Acquirer than specified in an earlier written notice to Licensor, or (b) with a party other than that specified in an earlier written notice. (c) In the event that Licensee, after complying with the right of first refusal procedure set forth in subsections (b)(i) through (b)(ii) of Paragraph 2.4, consummates a Transfer with a Third-Party Transferee in a transaction that results in Licensee receiving "Proceeds" (defined to mean cash, stock or other consideration solely attributable to the Transfer) from and on account of such a Transfer having a fair market value on the date of the closing of the transaction in an amount that is in excess of the Recoupment Amount (as defined in Paragraph 4.3.1 below) (the "Excess Amount"), Licensee agrees to pay Licensor an amount equal to [***]% of the Excess Amount. (d) In the event that Licensee, after complying with the applicable provisions of subsections (b)(i) through (b)(ii) of Paragraph 2.4, consummates a Transfer with a Third-Party Transferee, the terms of Paragraph 4.3.2 pertaining to royalties to be paid by such Third-Party Transferee on account of Net Sales of Products shall come into effect. In the event of such a Transfer with a Third-Party Transferee, any such Third-Party Transferee shall assume all of the obligations of Licensee hereunder and this Agreement shall be binding upon and inure to the benefit of such Third-Party Transferee." 3. Additional License Fees. Paragraph 4.2 of the License Agreement is hereby amended to strike the period at the end of subsection (c) and add the following after the word "aggregate": "; and (d) the sum of $[***] which sum shall be payable without regard to the limitation set forth in the preamble of this Section 4.2 relating to termination and which sum shall be payable in four (4) equal installments of $[***] on the following dates: (i) the Effective Date; (ii) April 30, 2002; (iii) July 31, 2002; and (iv) October 31, 2002. Paragraph 4.8 of the Agreement shall be applicable to any payments that are overdue and payable to Licensor under Paragraph 4.2(d) of this Agreement." 4. Royalties on Account of Net Sales. Paragraph 4.3 of the License Agreement is hereby amended and restated in its entirety to add the following after the heading of Paragraph 4.3: "4.3.1 Net Sales Made by Licensee. 3 (a) Licensee agrees to pay Licensor royalties as follows based on the annual Net Sales from the sale of Products: (i) [***]% of Net Sales until Licensee has received on account of Net Sales a total amount equal to the Recoupment Amount (as defined below), then (ii) [***]% of all Net Sales in excess of the Recoupment Amount. (b) For purposes of this Agreement, the term "Recoupment Amount" shall mean the amount derived from the following calculation: Recoupment Amount = $[***] U.S. PLUS ($[***] TIMES the number of Products sold from and after the Effective Date MINUS $[***] TIMES the number of Products in Licensee's inventory on the Effective Date) PLUS (Earned Royalties paid to Licensor from and after the Effective Date) MINUS (the Proceeds, if any, that Licensee receives from Merial as an upfront fee or other payment for entering into the Distribution Agreement). 4.3.2 Net Sales Made by a Third-Party Transferee in the Event of a Transfer. (a) In the event that a Transfer with a Third-Party Transferee is consummated, the Third-Party Transferee shall, notwithstanding and without regard to Paragraph 4.3.1, pay Licensor a royalty of [***] of Net Sales from the sale of Products by such Third-Party Transferee or its Affiliate (as hereinafter defined), whichever is greater. The term "Affiliate" shall mean (i) any business entity fifty percent (50%) or more of which is owned directly or indirectly by a Third-Party Transferee; (ii) any business entity which directly or indirectly owns fifty percent (50%) or more of a Third-Party Transferee; or (iii) any business entity under the direct or indirect control of any business entity described in (i) or (ii) above. (b) In the event that a Transfer with a Third-Party Transferee is consummated, Paragraphs 2.4(c) and 4.3.1 shall no longer apply or be of any force or effect with respect to any Third-Party Transferee. 4.3.3 Net Sales Made by an Acquirer in the Event of a Transfer. (a) In the event that a Transfer with an Acquirer is consummated, the Acquirer shall, notwithstanding and without regard to Paragraph 4.3.1, pay Licensor a royalty of [***]% of Net Sales from the sale of Products by such Acquirer. (b) In the event that a Transfer with an Acquirer is consummated, Paragraph 4.3.1 shall no longer apply or be of any force or effect with respect to any Acquirer." 4 5. Minimum Obligations in the Event of a Transfer. Paragraph 4.5 of the License Agreement is hereby amended and restated in its entirety to read as follows: "4.5 Minimum Royalty Obligation of "Third-Party Transferee" in the Event of a Transfer. In the event that a Transfer with a Third-Party Transferee is consummated, the Third-Party Transferee shall, in order to maintain its rights hereunder, pay Licensor minimum royalties in accordance with Paragraphs 4.4, 4.7 and the following: Minimum Royalty Payment Minimum Royalty Payment Per Contract Year Per Contract Quarter ----------------- -------------------- $[***] $[***]" 6. Termination. Paragraph 7.2 of the License Agreement is hereby amended and restated as follows: "(a) If Licensee is in material default of 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 period. (b) In the event that Licensee does not sell an "average" of [***] Products each calendar year commencing January 1, 2002 through December 31, 2004, measured on a cumulative basis and adjusted each calendar year during the term hereof in order to account for fluctuations in sales from year to year, Licensor shall have, as its sole and exclusive remedy and without any other recourse against Licensee as a result of such event, the right to terminate this Agreement by giving thirty (30) days' written notice of termination. (c) In the event that Licensee does not sell Products in each calendar year following December 31, 2004 sufficient to generate annual Net Sales of at least $[***], Licensor shall have, as its sole and exclusive remedy and without any other recourse against Licensee as a result of such event, the right to terminate this Agreement by giving thirty (30) days' written notice of termination. (d) In the event that a Transfer with an Acquirer is consummated and such Licensee does not either sell Products in each calendar year following December 31, 2003 sufficient to generate annual Net Sales of at least $[***], or, alternatively, pay Licensor the minimum royalties applicable to a Third-Party Transferee set forth and contemplated by Paragraphs 4.5 and 4.7, Licensor shall have, as its sole and exclusive 5 remedy and without any other recourse against Licensee as a result of such event, the right to terminate this Agreement by giving thirty (30) days' written notice of termination." 7. Continued Obligations. Paragraph 7.4 of the License Agreement is hereby amended to add the number "4.2(d)" after the number 3 and before the number 5 in the Paragraph such that Paragraph 4.2(d) as amended in Section A.3. of this Addendum shall survive the termination of the License Agreement. 8. Notices. Paragraph 9.5 of the License Agreement is amended to change the mailing and facsimile address of the Licensee such that the following shall be substituted for that which is currently set forth therein: "If to Licensee: CNS, Inc. 7615 Smetana Lane Eden Prairie, MN 55344 Attn: Marti Morfitt Fax No.: (952) 229-1701" B. Waiver and Release. In furtherance and not in limitation of the amendment set forth in and contemplated by Section A.5. above, Licensor hereby waives any and all right under the License Agreement to any minimum royalties that may be due, become due or have accrued or become due on or before the Effective Date, and hereby releases Licensee from any obligation, liability or responsibility with respect to the same. C. Permitted Sublicense in Favor of Merial or its Affiliates. To the extent that the grant of a sublicense by Licensee of any of the rights granted by Licensor to Licensee under or in connection with the License Agreement is necessary or desirable for Licensee to implement the Distribution Relationship with Merial or its Affiliates, Paragraph 2.3 of the License Agreement is hereby amended to permit Licensee to grant any such a sublicense to Merial or its Affiliates. D. Limited Cross-Licenses. 1. CNS. In the event that (i) Licensee terminates the License Agreement in accordance with Paragraph 7.3(a), or (ii) Licensor terminates the License Agreement in accordance with 7.2, the parties hereto agree that the following shall apply: a. License and Field of Use Restriction. Licensee shall grant to Licensor a limited, exclusive and worldwide license and/or sublicense to make, have made, use, sell or offer for sale products utilizing any of the inventions within the scope of any valid claim in the United States Patents identified on Schedule A (the "CNS Licensed Patents") or from any continuations, re-exams or re-issues relating to those patents together with any and all foreign counterparts; provided, however, that the license and/or sublicense granted hereunder shall be limited solely to the field of equine nasal support products or devices ("Licensor's Field of Use"). 6 b. Further Sublicenses and Assignments. Except as may be necessary or desirable to manufacture or have manufactured the equine nasal support products or devices, Licensor shall have no right to sublicense or assign any of the rights granted by Licensee to Licensor with respect to any of the CNS Licensed Patents; provided, however, that Licensor may assign, convey or transfer any and all of its rights under this Section D of this Addendum to a successor in interest to all of the assets, capital securities or membership interests of Licensor. c. Term. The licenses and/or sublicenses granted hereunder shall commence upon the termination of the License Agreement by Licensor or Licensee in accordance with Paragraph 7 and shall expire, unless earlier terminated pursuant to subsection (e) below, upon the earlier of: (i) the expiration of the last of the CNS Licensed Patents to expire; or (ii) the termination of Licensee's rights with respect any of the CNS Licensed Patents. d. Royalties. Licensor agrees to pay Licensee royalties based upon the Net Sales from the sale of equine nasal support products or devices of [***]% of Net Sales that, but for the license granted hereunder, would infringe any claims of the CNS Licensed Patents. All payments shall be due and payable to Licensee on a quarterly basis, and the provisions of Paragraphs 4.4, 4.8, 4.9 and 4.10 of the License Agreement shall be applicable and inure to the benefit of Licensee. e. Termination. If Licensor is in material default of any of its obligations under this Section D.1., Licensee shall have the right to terminate the licenses and/or sublicenses granted hereunder 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. 2. WinEase. In the event that (i) Licensee terminates the License Agreement in accordance with Paragraph 7.3(a), (ii) Licensor terminates the License Agreement in accordance with 7.2, or (iii) Licensee enters into a transaction that operates to effectuate a Transfer with a Third-Party Transferee, the parties hereto agree that the following shall apply: a. License and Field of Use Restriction. Licensor shall grant to Licensee a limited, exclusive and worldwide license and/or sublicense to make, have made, use, sell or offer for sale products utilizing any of the inventions within the scope of any valid claim in the United States patents and any patents which issue or have issued from the applications listed on Schedule B of this Addendum or from any continuations, re-exams or re-issues relating to those patents and applications, together with any and all foreign counterparts (the "WinEase Patents"); provided, however, that the licenses and/or sublicenses granted hereunder shall be limited solely to the field of human nasal dilation products or devices ("Licensee's Field of Use"). b. Further Sublicenses and Assignments. Except as may be necessary or desirable to manufacture or have manufactured any human nasal dilation products or devices, Licensee shall have no right to sublicense or assign any of the rights granted by 7 Licensor to Licensee with respect to any of the WinEase Patents; provided, however, that Licensee may assign, convey or transfer any and all of its rights under Section D of this Addendum to a successor in interest to all of the assets of Licensee relating to its human nasal dilation business or to all of its capital stock. c. Term. The licenses and/or sublicenses granted hereunder shall commence upon the termination of the License Agreement by Licensor or Licensee in accordance with Paragraph 7 and shall expire, unless earlier terminated pursuant to subsection (e) below, upon the expiration of the last of the WinEase Patents to expire. d. Royalties. Licensee agrees to pay Licensor royalties of [***]% of Net Sales from the sale of those human nasal dilation products or devices that, but for the license granted hereunder, would infringe any claims of the WinEase Patents (the "Covered CNS Products"); provided, however, that Licensee shall not be obligated to pay any royalties with respect to the sale of any Covered CNS Products or with respect to the use of any of WinEase Patents that relate to or result from any patent application filed between March 13, 1999 and the Effective Date (the "Excluded Patents"), it being understood and agreed that the licenses and/or sublicenses granted by Licensor to Licensee with respect to such Excluded Patents shall be on a royalty-free basis. All payments shall be due and payable to Licensor on a quarterly basis, and the provisions of Paragraphs 4.4, 4.8, 4.9 and 4.10 of the License Agreement shall be applicable and inure to the benefit of Licensor. e. Termination. If Licensee is in material default of any of its obligations under this Section D.1., Licensor shall have the right to terminate the licenses and/or sublicenses granted hereunder 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. 3. Miscellaneous. The following provisions shall apply in the event that the either paragraph 1 or paragraph 2 of this Section D becomes applicable: a. Right to Abate Infringement of Excluded Patents. In the event that either Licensor or Licensee become aware of any activity on the part of any third party which may constitute infringement of any of the Excluded Patents, such party shall give the other party written notice thereof. In the event of an infringement in Licensee's Field of Use, Licensee shall (for so long as its rights under Paragraph D.2 are in force and effect), at its sole discretion and expense, have the first exclusive right to initiate and thereafter maintain reasonable efforts to prevent and abate such infringement, including the initiation of appropriate civil action for infringement and the taking of such other action as it may determine to be necessary or desirable to enforce any of the Excluded Patents and/or any rights thereunder or relating thereto. In such event, (i) Licensor agrees to fully cooperate with Licensee and 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 desirable in conjunction therewith, and (ii) Licensee shall receive the full benefits of any action it takes pursuant to this paragraph, including retaining all sums recovered in any 8 such suit or in settlement thereof. In the event that Licensee fails or refuses to take or cause to be taken any such measures against any third party after six (6) months from the date of receipt of written notice to Licensee by Licensor of such infringement, Licensor may take such legal action in its own name and at its own expense upon giving twenty-one (21) days advance, written notice of its intention to do so. In this case, all damages recovered as a result of such action by Licensor shall be and become the property of Licensor. In the event that Licensor takes any action to prevent or abate an infringement by a third party of any of the Excluded Patents under this paragraph or otherwise, Licensee will fully cooperate with Licensor and, to the extent necessary to maintain suit under applicable law, 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 desirable in conjunction therewith. If Licensee litigates any matter relating to the Excluded Patents under this paragraph or otherwise, it shall first provide Licensor with ten (10) days advance written notice of its intention to commence such litigation which notice shall identify the name of the alleged third-party infringer, the infringing product and the patent involved. If either party litigates any matter relating to the Excluded Patents, the other party may, at its option and its cost and expense, participate in meetings with the litigating party and/or its counsel and receive all pleadings, documents and other related papers useful for the purposes of keeping the other party informed of the status of any proceedings commenced by the litigating party. b. General Provisions. All of the provisions of Section 9 of the License Agreement shall apply to the agreements contained in Section D of this Addendum. c. Survival. Section D of this Addendum shall survive the termination of the License Agreement. E. No Impairment. The provisions set forth in the License Agreement and not amended or altered by this Addendum shall remain in full force and effect and shall apply to this Addendum unless to do so would be inconsistent with the intentions of the parties as expressed in this Addendum. This Addendum supersedes and replaces any and all other amendments, whether written or oral, to the License Agreement that have been entered into by the parties prior to the date hereof. F. Further Assurances. The parties agree to cooperate and take such actions and execute such other documents and instruments as may be reasonably requested by the other party hereto in order to consummate the transactions and agreements set forth in or contemplated by this Addendum. G. Recitals. The Recitals set forth in this Addendum are true and correct, incorporated herein and made a part of the Addendum and the parties' agreement as set forth above. H. Capitalized Terms. Capitalized terms in this Addendum that are not defined shall have the meaning ascribed to such terms in the License Agreement unless the context requires otherwise. 9 IN WITNESS WHEREOF, the parties hereto have executed this Addendum as of the day and year first above written. CNS, INC. By: /s/ Daniel E. Cohen --------------------------------------- Its: Chairman -------------------------------------- WINEASE, LLC By: /s/ Edward F. Blach --------------------------------------- Its: President/CEO -------------------------------------- 10 SCHEDULE A ---------- CNS LICENSED PATENTS -------------------- United States Patent Nos.: 1. 5,533,499 2. 5,533,503 3. 5,653,224 4. 5,476,091 5. 5,549,103 6. 5,611,333 7. 6,318,362 11 SCHEDULE B ---------- WINEASE PATENTS --------------- United States Patent Nos.: 1. 5,913,873 2. 6,017,457 3. 6,203,560 4. 6,033,422 United States Pending Patent Application Nos.: 1. 09/438,676 2. 09/264,464 3. 09/379,425 4. 09/713,308 12 EX-23.1 5 cns021471_ex23.txt INDEPENDENT AUDITORS' CONSENT Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT The Board of Directors CNS, Inc.: We consent to incorporation by reference in the registration statements Nos. 333-60017, 33-29454, 33- 42971 and 33-59719 on Form S-8 of CNS, Inc. of our report dated January 22, 2002, relating to the consolidated balance sheets of CNS, Inc. and subsidiaries as of December 31, 2001, and 2000, and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2001, which report is included in the December 31, 2001, annual report on Form 10-K of CNS, Inc. /s/ KPMG LLP Minneapolis, Minnesota March 25, 2002 -----END PRIVACY-ENHANCED MESSAGE-----

TABLE OF CONTENTS

Forward-Looking Statements

PART I

Item 1. BUSINESS

General

Management

Products

Markets

Business Strategies

Marketing Strategies

New Products Strategy

Domestic Distribution

International Distribution

Manufacturing and Operations

Competition

Government Regulation

Patents, Trademarks and Proprietary Rights

Employees

EXECUTIVE OFFICERS OF THE COMPANY

Item 2. PROPERTIES

Item 3. LEGAL PROCEEDINGS

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

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

Shareholders

Dividends

Item 6. SELECTED FINANCIAL DATA

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Seasonality

Liquidity and Capital Resources

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors

Executive Officers

Item 11. EXECUTIVE COMPENSATION

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS