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No. of Recommendations: 8
Fleabuss said:
”In terms of market share, I'm sure I read somewhere(sorry) that although CNS beat expectations that it was because of their new product and not Breath Right. I remember reading that the Breath Right portion of earnings was down 5cents over last year.”

Thanks for clarifying that fleabuss. Since I am long on CNS Inc., I wanted to get to the bottom of this. I just read through the recent 10-Q filing (filed Nov. 4, 2004 for the quarter ending Sept. 30), and found what you are referring to:

”Breathe Right net sales were $27.1 million, a decrease of 5.3% versus $28.6 million in the prior year and FiberChoice net sales were $5.2 million, an increase of 18.8% from $4.4 million for the same period of 2003.” Also the diluted net income per share was down $ .05 as compared to the year earlier quarter, at $ .24 versus $ .29.

But the question I had is what caused this? Was it a decline in market share, or were there other factors? In the section titled Management's Discussion and Analysis of Financial Condition and Results of Operations, I found the answers.

First off they said ”The Company has experienced in the past, and expects to experience in the future, quarterly fluctuations in both domestic and international sales and earnings. These fluctuations are due in part to timing and levels of marketing promotions and seasonality of sales, as described below, as well as increases and decreases in purchases by the Company's customers and distributors in anticipation of future demand by consumers.” Yep, I remember the deal about shipments to Japan distributors some time back causing a spike in demand that distorted earnings and required explaining last year. So lets see what is happening now.

”Breathe Right brand sales decreased by $1.1 million dollars primarily as the result of the 2003 comparable quarter including new product pipeline shipments of Vapor Shot! personal vaporizer.” Ah. When they introduced the Vapor Shot in the year ago quarter they had a large quantity of product shipments to fill up the pipeline, and this artificially inflated total sales for the Breathe Right brand which includes Vapor Shot. This explains most of the “decline” in Breathe Right sales. It wasn't really a decline in the sale of nasal strips at all. So there is not a loss of market share, but rather sales fluctuations mostly related to Vapor Shot.

Ok, so what about the 5 cent decline in earnings per share? I don't like that; lets see what management has to say. ”The decline in operating income as a percentage of sales was caused by the phasing of advertising and promotion programs and hence the related expense to earlier in the fiscal year, partially offset by improved gross margins.” OK, they are blaming it on advertising expense that they started earlier in the season. Lets see if the figures back this up. A look at the income statement shows advertising and promotion expense for the September quarter of 2004 was $5.7 million compared to $4.2 million for the same period of 2003. So if you look at Gross Profit before operating expenses (which would be the figure before advertising is deducted), we see gross profit really was higher this quarter than a year ago. So they are not blowing smoke, it was the advertising expense.

So while I am not thrilled with the performance this quarter, I think management has reasonable explanations about what is going on, and it is not loss of market share or erosion of gross margins. That's a relief. I still want to watch the situation closely, especially to see if this increased advertising has a positive impact. The coming quarter is supposed to be the good season for them, colds and flu and all that. So lets see how they do. I think it is pre-mature to bail out now.

Oh, and it wasn't all explanations of why things aren't as bad as they look; there was some good news in the 10-Q too:

”The Company has received notice of a favorable court decision relating to an import duty appeal that may result in the refund of previously paid European Community import duties on Breathe Right nasal strips. The estimated amount of the potential refund, payable in Euros, is approximately $1.0 million. Assuming satisfactory completion of audit procedures performed by Dutch customs, the Company expects to receive the refund during the current fiscal year and will recognize the refund at the time of receipt.”

Fool On,
–Bill
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