CNS, Inc.

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CNS, Inc.

4400 West 78th Street
Minneapolis, Minnesota 55435
U.S.A.
(612) 820-6696
Fax: (612) 835-5229
Web site: http://www.breathright.com

Public Company
Founded: 1982
Stock Exchanges: NASDAQ
Employees: 40
Sales: $85.9 million (1996)
SICs: 3842 Surgical Appliances And Supplies

Formed as a medical equipment company, CNS, Inc. achieved rapid growth and profitability with the Breathe Right nasal dilator, an adhesive strip worn across the bridge of the nose. Breathe Right, a leading seller among products in the domestic cough and cold market, is an alternative to decongestant drugs and nasal sprays. By reducing airway resistance the strip also has been shown to eliminate or reduce snoring—perhaps the largest potential market for Breathe Right. CNS introduced an analgesic patch for temporary pain relief in 1997 and is developing other medical consumer products.

First Product Line: Brain Wave Monitors

Dr. Daniel Cohen and Dr. Frederick Strobl founded CNS, Inc. in 1982 in order to develop equipment for brain wave analysis. The men met while residents in the neurology department at the University of Minnesota Hospitals and discovered each wanted to use their medical training in a nontraditional capacity. Strobl, also an electrical engineer, was interested in biomedical engineering, and Cohen leaned toward using his medical knowledge in a business context.

Lawrence Sutin wrote in the October 1985 Minnesota Business Journal, ’ ’In their initial 1978 talks, the two doctors agreed that the state of the art in monitoring equipment for brain activity was, in Strobl’s words, ’in a relatively primitive state.’ “Standard electroencephalograph (EEC) machines printed out the brain’s electrical signals as marks on a continuous stream of paper and were difficult to read and analyze quickly. Strobl and Cohen wanted to develop a machine which could be easily used in the operating room—monitoring brain activity during procedures such as open heart surgery could reduce the incidents of brain damage through early detection of dangerously diminished blood supply to the brain.

The men initially formed a partnership and worked independently. In late 1982, they had advanced far enough in their research to hire an engineer and incorporate the business. A private stock offering to friends and fellow physicians raised nearly $350,000. In 1983, with more engineers and research personnel on board, Strobl and Cohen narrowed the scope of their activities in order to focus on product development. Additional rounds of stock offerings were made through financial institutions. And their first outside manager was hired in early 1984; but he left the company within a year over marketing strategy differences.

CNS’s first product, the CNS-16 Tracer—a personal computer with a circuit board to receive brain wave signals via electrodes and software to measure electrical changes—was approved by the Food and Drug Administration (FDA) in December 1984. Strobl led the marketing efforts for the $75,000 machine. Cohen handled the general management of the company. They quickly found that changes in Medicare and Medicaid treatment reimbursements that were made in the early 1980s had tightened hospital budgets for new equipment. In 1985, CNS began to modify the system and software for use in sleep disorder clinics while they continued to try to build the surgical market.

The Mayo Clinic in Rochester, Minnesota, Twin Cities Hospitals, and other users of the CNS equipment had responded favorably to the product, but sales continued to be slow. To generate interest among the general public, CNS loaned a piece of equipment to a daytime soap opera and two years later to the television medical drama “St. Elsewhere.” The tactic generated interest but no sales.

CNS Goes Public

CNS made its initial public offering (IPO) in June 1987 and generated $3.2 million. But Diane Beulke wrote in a November 1987 Minneapolis/St. Paul CityBusiness, ”Five-year-old CNS, Inc. of Eden Prairie has been fighting an uphill battle to convince Medicare rule makers and heart surgeons that its brain wave monitors are an operating room necessity.”

In 1987, the company’s sleep lab monitoring equipment brought in nearly 60 percent of the $1.75 million in sales. CNS’s computer-aided EEGs reduced the amount of time required to read and analyze the data gathered on factors such as eye movement, muscle activity, and oxygen level, which were used to diagnosis sleep disorders. Cost-effectiveness proved to be more readily measured in the sleep lab than in the operating room.

The company lost nearly $5 million from 1985 through 1987. Only 60 of the operating room monitors had been sold since 1984. CNS appointed Fred Brooks, a professional manager with experience in medical devise companies, to the position of president in July 1990. Cohen continued to serve as CEO.

The company reported profits for the first time in 1990 on revenues of $7.5 million. The number of sleep clinics had risen from 300 in 1985 to about 2000 by 1991. CNS’s equipment ranged from $50,000 to $120,000, but most clinics needed one or two machines; in contrast, hospitals needed a brain monitor for each operating room. The company was pumping 12 percent of sales into product development in order to expand into areas such as home-use sleep monitors.

A New Direction

In October 1991, Cohen met with Bruce Johnson, who was seeking help to scientifically test the effectiveness of an external nasal dilator he had invented. Johnson, a mechanical designer in the electronics industry, formed his own consulting business, Creative Integration and Design Inc., in 1988, after being laid off by his employer of 10 years during the prior year. About the same time he was inspired to try a new approach to relieve his on-going allergy-related breathing problems.

Johnson had used a variety of methods to dilate his nasal passages internally, but they were uncomfortable. A building with an architectural design using external supports triggered an idea: he could dilate the nostrils externally. Eric J. Wieffering wrote in a September 1995 Corporate Report article, “For the next three years, he worked on a spring-loaded adhesive strip that would stretch across the outside of his nose, lift his nostrils gently, and allow him to sleep. He wore prototypes to bed and around the neighborhood. He endured the good-natured taunts of his son and neighborhood children, who asked, ’What happened to your face, Mr. Johnson?’ “He applied for a patent on the device in 1990.

Cohen tried the strip and came to the same conclusion as Johnson: the potential market for a product that provided non-medicinal relief of nasal congestion was huge. Instead of agreeing to test the prototype, Cohen offered to buy the rights to manufacture and sell the nasal strip. CNS would pay for the testing and clinical trials necessary for FDA approval of the product. Johnson would receive warrants for shares of CNS, a percentage of gross sales for the life of the patent, and work with CNS to further refine the strip. In February 1992, CNS announced the licensing agreement with Creative Integration and Design for the nasal dilator and the resignation of Brooks as president of CNS. Cohen assumed his duties.

Domestic sales of the larger lab-based diagnostic equipment fell in 1992 due to the uncertainty surrounding rules regulating third-party reimbursement for sleep testing. The company continued clinical studies on the benefits of the external nasal dilator and planned to begin marketing the product to hospitals and home care providers when cleared by the FDA. A secondary stock offering brought in additional funds in 1992. After a profitable 1990, CNS had reported losses in 1991 and then again in 1992.

A new president and chief operating officer, Richard E. Jahnke, came on board in March 1993. He had 20 years experience in marketing and general management with large corporations including 3M. In October, the FDA approved marketing of the Breathe Right strip as a medical device. CNS had shown it improved nasal breathing by reducing air resistance an average of 31 percent. CNS stock per share price climbed from about $4 to $14 within a month. According to Tony Carideo in a November Star Tribune article, “One thing clearly driving the issue is the enormous amount of publicity the product is receiving.”

To build consumer demand for the Breathe Right strip, Cohen had been giving 10 to 20 interviews a week, blanketing radio, television, newspapers, and magazines. Although CNS had commitments from five of the top ten pharmaceutical wholesalers to supply the strips, customers had to request them before drugstores would create shelf space for the new product, a 10-count box selling for about $5. Breathe Right sales for 1993 were primarily in the Twin Cities area and other cities where they had received media coverage. The lengthy FDA approval process for Breathe Right plus continuing uncertainty in the U.S. sleep disorder market contributed to losses of $1.4 million for 1993.

Another stock offering brought in $8.6 million in April 1994. Breathe Right strips gained shelf space in Minneapolis-based Snyder’s Drug Stores Inc. and then in two of the country’s largest drug store chains, Walgreen’s and Eckerd Drug Stores, in the beginning of the year. With the product now available in some stores, CNS began making plans for more traditional advertising and promotion. But the company continued to pursue creative low-cost promotional ideas.

In October 1994, Cohen sent a letter and case of Breathe Right strips to all of the National Football League (NFL) trainers. The Philadelphia Eagle trainer gave Herschel Walker a strip when he complained of cold symptoms. San Francisco 49er Jerry Rice, who had chronic nasal congestion, heard that Walker had worn the strip during a game and then donned a Breathe Right himself on a nationally-televised Monday Night Football. Wall Street Journal’s ”Heard on the street” column featured CNS a few days later. Fourth quarter sales of Breathe Right doubled and produced about one-half the year’s total sales of $2.8 million.

Super Sales

The Breathe Right received more national exposure in January 1995, when about eight Super Bowl XXIX players wore the strip. Additional publicity came in February when Rush Limbaugh told his radio and television audiences that he and his wife had used and liked Breathe Right. National media attention sent sales skyrocketing. First quarter sales were $7.5 million. CNS could not keep up with demand. In order to finance the backlog of orders, CNS sold its diagnostic equipment business—which had annual sales of about $7 million—for about $6 million. CNS stock was on the ascent as well. Per share price reached the $30 range prior to a two-for-one stock split in June 1995. In August, CNS announced an agreement with 3M to distribute Breathe Right internationally.

CNS rounded out its spectacular year with two significant events. The FDA approved the marketing of Breathe Right for the reduction or elimination of snoring: clinical studies had shown that 75 percent of participants snored less often and less loudly when using the strip. With about 40 million chronic snorers in the United States, CNS saw snorers as the largest potential market for its product. And one day after receiving the FDA approval, the patent on Breathe Right was granted. “The timing of this event was crucial as knock-off products were increasing in number and retailers were considering offering private label products,” said Cohen and Jahnke in the 1995 annual report.

Revenues for 1995 were $48.5 million, and net income on continuing operations was $13.3 million or 72 cents per share. By the end of the year the Breathe Right strip was in 98 percent of all drugstores and mass merchants and estimated to be in 70 percent of all grocery stores. The 30-count box, introduced mid-year, had grown to 25 percent of sales.

CNS placed its first network television ad in 1996: the two 30-second Super Bowl XXX spots, which targeted snorers, cost $1.6 million. Also in 1996, the company received additional FDA approvals for marketing the Breathe Right strip. One for relief of nasal congestion and stuffy nose and another for the temporary relief of breathing difficulties due to a deviated nasal septum—a bend in the cartilage and/or bone which divides the nostrils.

Building Markets

In 1996, CNS accelerated its advertising with network television ads during the NFL season and year-round radio, cable television, and print ads which were bumped up during the cough and cold season. CNS raised $35 million in a public offering to finance future growth and captured the number four spot on Fortune magazine’s list of the nation’s fastest-growing companies.

Clinical studies in support of additional uses for Breathe Right continued in 1996. Benefits related to athletic endurance and performance, asthma- and emphysema-related breathing problems, and sleep quality were under investigation. International sales climbed to 30 percent of revenues in 1996 as 3M built inventory and introduced the product in 30 foreign countries. Net sales for the year were $85.9 million or an increase of 77 percent. Net income was $15.5 million.

In 1997, CNS was the smallest company to buy ad time for Super Bowl XXXI. Joint promotions with Tylenol PM and the Universal Pictures movie Leave It To Beaver were also slated for later in the year. TheraPatch, an external analgesic product test-marketed in 1996 was distributed nationally beginning in 1997—the medicated patch market had climbed from $134 million in 1985 to $262 million in 1996. But, Pollen Guard Gel, a product being developed to reduce inhalation of airborne allergens, was found to be ineffective and was dropped. CNS hoped to introduce an appetite suppressant or smoking cessation product in the form of a lozenge and gum in 1998.

An estimated 10.5 percent of households of potential domestic customers used CNS products in the beginning of 1997. Piper Jaffray concluded in a first quarter analysis of CNS that “Breathe Right will be a very successful product over time due to its large potential markets, its effective relief of nasal congestion and snoring, and its relatively high rate of repeat users.”