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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
F O R M 10 - K
[x] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 (Fee Required)
For the fiscal year ended March 31, 1997
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (No Fee Required)
For the transition period from __________ to __________
Commission file number 0-11363
Chad Therapeutics, Inc.
(Exact name of registrant as specified in its charter)
California 95-3792700
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
21622 Plummer Street, Chatsworth, CA 91311
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 882-0883
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, $.01 par value
(Title of class)
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 disclosures of delinquent filers pursuant to Item
405 of Regulation SK (229.405 of this chapter) 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. [ ]
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The aggregate market value of the voting shares held by non-affiliates of
the Registrant on June 13, 1997 (based on the average over-the-counter bid and
asked prices of such stock on such date) was $88,288,000.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of June 13, 1997:
Common Shares 9,948,000
Portions of the Registrant's definitive Proxy Statement for its September
9, 1997, Shareholders' meeting ("Proxy Statement") (which Proxy Statement has
not been filed as of the date hereof) are incorporated into Part III as set
forth herein. Portions of the Registrant's Annual Report to Shareholders for the
year ended March 31, 1997 ("Annual Report") are incorporated into Part II as set
forth herein and only such portions of the Annual Report as are specifically
incorporated by reference are thereby made a part of this Annual Report on Form
10-K.
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PART I
Item 1. Business
Chad Therapeutics, Inc. ("CHAD" or the "Company") was organized in August,
1982, to develop, produce and market respiratory care devices designed to
improve the efficiency of oxygen delivery systems for both home and hospital
treatment of patients who require supplemental oxygen. The Company introduced
its first respiratory care device in the market in June, 1983, and has
introduced additional respiratory care devices in subsequent years.
Pulmonary Disease and Oxygen Therapy
The Company was organized to pursue the development and marketing of
devices which improve the efficiency of systems used to administer oxygen to
patients requiring supplemental oxygen. These are primarily patients suffering
from chronic obstructive pulmonary diseases.
Chronic obstructive pulmonary diseases (COPD) are progressive, debilitating
conditions that affect millions of Americans, severely limiting their activities
and shortening their lives. Such conditions, which include chronic bronchitis,
emphysema and severe asthma, decrease the capacity of the lungs to oxygenate the
blood. To make up for this deficiency, it is common medical practice to
administer supplemental oxygen, usually on a 24 hours per day basis in an amount
sufficient to increase blood oxygenation to near normal levels.
A report issued in September, 1981, by the National Heart, Lung and Blood
Institute of the National Institutes of Health (NIH) stated that chronic
obstructive pulmonary diseases were the fastest rising cause of death in the
United States, accounting for approximately 2.5% of all deaths and costing more
than $15 billion a year in health care and lost time and wages. The NIH Report
estimated that in 1981 there were approximately 9 million people in the United
States suffering from chronic bronchitis and emphysema.
More recently, the Epidemiology and Statistics Unit of the American Lung
Association reported that in 1989 there were 14.6 million Americans suffering
from COPD. This report also notes that the death rate from COPD has increased by
28.5 percent in the decade from 1979 to 1989. Some authorities estimate that as
many as 20 million Americans who are now affected by COPD will eventually
require supplemental oxygen.
Although precise data are not available, various individual and
institutional sources and reports estimate that there are more than 1 million
home care patients receiving supplementary
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administration of oxygen. Total dealer revenues for home oxygen therapy were
estimated at over $2 billion for 1996. Medicare, which accounts for about 60% of
home oxygen dealers' revenues, expected to spend almost $1.5 billion in 1996 for
home oxygen as compared to $1.4 billion in 1995 according to officials of the
Congressional Budget Office. Market revenues for home oxygen have grown
consistently at 8-10% per year for the past five years. This is due to the
increasing number of COPD patients as well as the move to home care and out of
hospitals. Growth in the utilization rate for home oxygen is projected by the
Congressional Budget Office to continue at a rate averaging approximately 8% per
year through 2002.
Chronic obstructive pulmonary diseases are also prevalent in other
countries, particularly in some European nations where the incidence is higher
than in the United States. The potential international market for home oxygen is
expected to grow to 150% of the U.S. market before the end of the decade.
The primary oxygen supply for home patients is provided from cylinders
containing compressed gaseous oxygen (5-10% of users), reservoirs containing
liquid oxygen (20-25%) or by means of concentrators which concentrate oxygen
from the ambient air (65-75%).
Standard oxygen delivery systems are characteristically inefficient,
permitting over 67% of the oxygen supply delivered to the patient to be wasted,
primarily because the oxygen is administered steadily to the patient, even while
he is exhaling. Since the normal breathing cycle consists of an exhalation
period which is approximately twice as long as the inhalation period, at least
two-thirds of the oxygen from this continuous flow system is wasted.
Furthermore, it is generally accepted that the oxygen breathed in during the
first one-third of the inhalation period provides most of the oxygenation
benefit to the patient.
In June, 1989, the home oxygen market changed. A new procedure for payment
by Medicare for home oxygen services became effective. This new procedure
provides a prospective flat fee monthly payment based solely on the patient's
prescribed oxygen requirement and disregards modality, the type of system in
use. Prior to that time, dealers were reimbursed on the basis of total oxygen
delivered by the dealer and reimbursement also varied based on the modality used
and other variables. The prior procedure tended to encourage waste and
inefficiency. Consequently, with the incentive to operate efficiently,
inexpensive concentrators have grown in popularity because of low cost and less
frequent servicing requirements. At the same time interest heightened in oxygen
conserving devices which can extend the life of oxygen supplies and reduce
service calls by dealers.
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There is also a separate fixed allowance from Medicare for patients who
need to be mobile and therefore require portable oxygen systems.
Mobility has increased in importance as the treatment of pulmonary patients
has moved away from hospitals and into home care. Also, leading authorities now
state that maintenance and improvement of the patient's quality of life should
be the major objective in the treatment of COPD. Maintaining quality of life and
compliance with prescribed exercise programs require that the patient be as
mobile as possible and thus increase the demand for portable oxygen equipment.
CHAD's Products
Recognizing the need for more efficient oxygen delivery systems, the
Company has pursued, since its inception, the development and marketing of
devices which are designed to conserve oxygen. The benefits of such improvements
include substantial cost savings and increased mobility for ambulatory patients
who require portable oxygen supplies. These devices extend the life of oxygen
supplies, make possible more compact and longer lasting portable systems and
thereby improve the quality of life for home oxygen patients.
OXYMIZER and OXYMIZER Pendant Oxygen-Conserving Devices. In June, 1983, the
Company began marketing its first product, the OXYMIZER disposable
oxygen-conserving device, a unique, patented, disposable device developed to
provide up to 4 to 1 savings of oxygen when used with any oxygen supply source.
The OXYMIZER device contains a collapsible reservoir which captures
incoming oxygen delivered during expiration and prevents its waste. The oxygen
captured in this reservoir is then inhaled by the patient during the first
instant of his next inspiration. The OXYMIZER device thus both conserves oxygen
and provides the patient with an extra rich supply of oxygen at the beginning of
the inhalation period when it can be most effectively utilized.
Extensive clinical testing and trials over the past ten years have
repeatedly demonstrated that patients using the OXYMIZER device are able to
achieve equivalent blood oxygenation levels while using significantly less
oxygen. There have been more than 32 clinical evaluations from institutions
worldwide, that have confirmed the efficacy and oxygen savings realized by
patients who use the OXYMIZER devices.
The greater efficiency provided by the OXYMIZER devices over standard
oxygen delivery systems also permits home health care patients to achieve
greater mobility by enabling them to use smaller portable cylinders or by
obtaining two to four times the life from standard sized portable cylinders.
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For home oxygen dealers the disposable OXYMIZER devices afford the cost
advantages of oxygen conservation without capital investment in expensive
equipment.
In hospitals the OXYMIZER devices are reported to be frequently used for
maintenance of certain patients requiring higher flow levels of oxygen without
having to resort to uncomfortable oxygen masks.
The Company is pursuing a marketing strategy which emphasizes the cost
savings, efficiencies and level of patient comfort associated with the use of
the OXYMIZER devices. See "Marketing" and "Competition".
The OXYMIZER Pendant device is similar to the OXYMIZER device, except that
its reservoir is located in a "pendant" which hangs over the patient's chest
rather than under the nose. The OXYMIZER Pendant has a more traditional
appearance than the OXYMIZER. The Company began marketing the OXYMIZER Pendant
in August, 1984, and to date sales have approximated those achieved by the
OXYMIZER device. Total sales of these two devices accounted for approximately 3%
of the Company's sales in 1997.
OXYMATIC Electronic Oxygen Conservers. The Company began marketing the
OXYMATIC conserver in March, 1986. This product is a small electronic device,
designed for use with portable oxygen systems. The OXYMATIC Model 201 conserver
electronically senses the optimal moment in the breathing cycle for delivery of
oxygen and at that moment, releases a very brief pulse of oxygen to the patient.
The OXYMATIC conserver concentrates the administration of oxygen during the
first one-third of the inhalation phase, when oxygen is most efficiently
utilized. Through its optimal efficiency the OXYMATIC electronic conserver makes
possible oxygen savings ratios of from 4 to 1 up to 12 to 1 depending on the
user's breathing rate. In clinical experience the average saving has been shown
to be 7 to 1 - about twice the efficiency of most competitive products. There
have been at least twelve controlled clinical trials and studies of patient
groups using the OXYMATIC conserver, all of which have confirmed its efficacy
and efficiency.
In May, 1995, the Company introduced the new OXYMATIC Model 301 which
replaces the Model 201. This new model incorporates improved electronics,
providing a longer battery life and other improvements which make it more user
friendly.
In June, 1993, the Company introduced a different version of the OXYMATIC
conserver, the OXYMATIC - 2400. This model incorporates substantial improvements
and additional features, such as an alarm system, which are designed to allow it
to be used 24
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hours a day with both primary and portable oxygen sources. The OXYMATIC - 2400
conserver affords the same oxygen savings ratios as the original OXYMATIC
conserver.
The OXYMATIC conservers accounted for approximately 44% of the Company's
sales in 1997, with 21% of these sales relating to sales of the OXYMATIC - 2400.
These amounts do not include OXYMATIC devices sold as part of OXYLITE systems.
OXYLITE Complete Portable Oxygen System. The Company also markets eight
OXYLITE complete portable oxygen systems, each of which is available with either
the OXYMATIC Model 301 conserver or the OXYMATIC - 2400 conserver. These systems
combine the OXYMATIC electronic oxygen conserver with small, lightweight oxygen
cylinders and lightweight pressure regulators in an attractive carrying pouch.
The OXYMATIC conserver extends the time the contents of the cylinders will
last by an average of seven times. They provide ambulatory patients with greater
mobility and less weight. These systems offer a superior alternative to commonly
used liquid oxygen systems for mobile patients and are more cost effective for
homecare dealers to supply. OXYLITE system and cylinder sales in 1997 accounted
for approximately 46% of the Company's total sales, of which 52% represents the
sales value of OXYMATIC conservers.
OXYFILL Refilling Systems. In March, 1996, the Company began marketing the
OXYFILL oxygen cylinder refilling systems which were designed to reduce the home
oxygen dealers costs of providing ambulatory oxygen to patients using the
Company's OXYLITE portable oxygen systems. These refilling systems allow the
home care dealer to refill cylinders at his base facility or in the patient's
driveway and thereby reduce purchases and inventory of oxygen cylinders, reduce
refill costs and gain more control over their oxygen business. To date, there
have been limited sales of the OXYFILL refilling systems.
OXYCOIL Coiled Oxygen Tubing. In January, 1986, the Company began marketing
the OXYCOIL coiled oxygen tubing, a device which replaces the standard supply
tubing for the OXYMIZER devices, the OXYMATIC conserver or conventional nasal
cannulas. The OXYCOIL tubing is a convenience and safety device which can be
used with any oxygen system to help keep the supply tubing out of the patients'
way, thus minimizing the tripping and tangling problems associated with standard
supply tubing. OXYCOIL tubing sales in 1997 accounted for approximately 1% of
the Company's total sales.
The technology for each of the devices described above belongs to the
inventors thereof. The Company has acquired exclusive licenses to manufacture
and market the OXYMIZER device, the OXYMIZER Pendant device, the OXYMATIC
conservers and the OXYCOIL tubing. See "Licensing and Related Agreements".
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Other Products. The Company also offers a variety of ancillary products
which support the principal oxygen conserving products. These include oxygen
cylinders of various sizes and compositions, regulators, cannulas and connecting
tubing and assorted carrying pouches, which account for less than 6% of total
sales in 1997.
Products Under Development
It is the Company's objective to continuously improve and add to its oxygen
conserving and related products. In April, 1996, the Company entered into an
exclusive development contract with an outside vendor to develop unique oxygen
therapy products. If the project is successful, the Company intends to begin
marketing the first product in fiscal 1998. No assurance can be given that any
products developed pursuant to this contract will be successfully marketed or
that the Company will ever derive any revenues or earnings from the sale of such
product.
Research and Development
For the year ended March 31, 1997, the Company expended approximately
$910,000 on research and development and has expended approximately $1,963,000
since its inception in August, 1982. The Company operates in an industry which
is subject to rapid technological change, and its ability to compete
successfully depends upon, among other things, its ability to stay abreast or
ahead of new technological developments. Accordingly, the Company expects to
expend increasing amounts for the development or acquisition of new products or
the improvement of existing products. In the next fiscal year the Company
expects to spend approximately $925,000 on several projects. The Company
conducts research and development in the electronics area internally and also
utilizes the services of outside firms and consultants for its research and
development activities.
Licensing and Related Agreements
The Company has entered into license agreements (the "Inventors License
Agreements") with Brian L. Tiep, M.D., Robert E. Phillips and Ben A. Otsap, the
inventors of the OXYMIZER device (the "Inventors"), with respect to that device
and each of the additional oxygen conserving devices developed by them. At the
present time, the Company has licensed the OXYMIZER device, the OXYMIZER Pendant
device and the OXYMATIC conserver, thereby acquiring exclusive rights to
manufacture and market such products.
Pursuant to the Inventors License Agreements, the Inventors grant to the
Company an exclusive license (with the right to grant sublicenses) to
manufacture, use and sell such device. The Inventors License Agreements provide
that the Company pay royalties to the Inventors on the net proceeds of sales of
the device covered
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by the agreement at the rate of 6% on amounts up to $10 million and 3% on
amounts of $10 million or more. The Inventors License Agreements also provide
that the Company pay minimum advance royalties for each license year in the
amount of $10,000 for each year. The advance payments are to be applied toward
royalties payable for the corresponding license year, and any amounts paid by
the Company under one agreement (except those on the OXYMIZER device), in excess
of the minimum, may be applied by the Company against the minimum payable under
any other such agreement. The Company is obligated to prosecute and defend, at
its own expense, any infringement suits related to manufacture or sale of each
device covered by any such agreement.
Each Inventors License Agreement continues until the expiration of the last
to expire of any patent covering the related device or, if no patent issues, for
17 years. The Inventors may terminate the Inventors License Agreements at an
earlier date if the Company is in arrears for 60 days on any royalty payment or
if the Company defaults in performing any other term of the agreement and fails
to cure such default within 60 days.
Manufacturing and Sources of Supply
The Company tests and packages its products in its own facility. Some of
its other manufacturing processes are conducted by other firms and the Company
expects to continue using outside firms for certain manufacturing processes for
the foreseeable future. All outside manufacturing is conducted under the
supervision and control of the Company and with tooling provided by the Company.
Pursuant to an oral agreement, the Company purchases semi-finished units of
the OXYMIZER and OXYMIZER Pendant devices from a supplier in Southern
California. Final assembly and packaging are completed at the Company's
facilities. The Company does not contemplate entering into a formal written
agreement for these units. This arrangement is terminable at will by either
party. The Company believes that other injection molding facilities would be
available in the event of a termination of this arrangement.
Pursuant to a written agreement, the Company purchases the OXYMATIC 2400
conserver from a supplier in Southern California. This arrangement is terminable
with notice by either party. The Company believes that other electronic assembly
facilities would be available in the event of a termination of the agreement.
Production of the OXYMATIC Model 301 is being handled internally with only
a portion of electronic assembly being subcontracted outside the Company. The
Company is currently subcontracting with two electronic assembly facilities and
believes that other facilities would be available in the event of an
interruption of supply from the existing facilities.
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Pursuant to oral agreements, the Company purchases components for its
OXYLITE systems (other than the OXYMATIC conserver) from several suppliers.
These arrangements are terminable at will and the Company believes other
suppliers would be available in the event of termination of these arrangements.
The Company is not aware of any shortages of materials necessary for the
manufacture of its products. The Company provides customers the right to return
merchandise for credit but does not provide extended payment terms.
Marketing
The Company's products are designed to reduce the cost of health care while
maintaining or enhancing the therapeutic benefits to the patient, and improving
the user's quality of life. The Company's marketing efforts have focused
primarily on providing home oxygen suppliers with products that they can utilize
to increase their revenues, while reducing their costs.
Homecare dealers have reportedly increased their revenues by using the
Company's OXYLITE complete portable oxygen systems or by locally assembling
small portable systems incorporating the Company's OXYMATIC conserver as a
vehicle to attract new and additional patients to their business. The Company
believes these lightweight, long-lasting portable systems have both high
professional and patient acceptance which allows the supplier promoting these
products to attract new and additional customers. The Company has been advised
that medical professionals, who frequently refer patients to specific home
oxygen suppliers, find that these systems assist patients in more easily
complying with prescribed exercise programs and help them to achieve the
therapeutic benefits of maintaining a lifestyle as normal as possible. Patients,
most of whom are free to select their oxygen supplier, are reportedly receptive
to changing suppliers in order to obtain equipment that will allow them to
travel and maintain their quality of life.
Approximately 80% of all home oxygen patients are covered by Medicare and
other government ptograms. Since June 1989, home oxygen suppliers have been
reimbursed by Medicare on a fixed monthly fee basis. The monthly reimbursement
amount does not vary, as in the past, with either the type of oxygen delivery
equipment provided or the amount of oxygen supplied. Since monthly per patient
revenues are fixed, home oxygen suppliers can only increase their per patient
profitability by reducing costs. The Company's oxygen conserving products allow
these suppliers to decrease their costs while providing their patients with
improved therapeutic benefits and quality of life.
While the home respiratory care dealer remains the primary focus of the
Company's marketing efforts, this focus was augmented
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recently by a major effort to increase professional awareness. Promotional
programs were initiated which targeted respiratory care physicians, nurses and
therapists. A Medical Advisory Committee was formed composed of nine physicians
who are among the world's leading respiratory authorities.
The Company markets its products directly to home oxygen suppliers
throughout the U.S. The Company currently has a Marketing Director, a Marketing
Manager, a marketing assistant, a National Sales Manager and six in-house
customer service representatives who are in regular and frequent proactive
telephone sales contact with customers and potential customers. In the past, the
Company extensively tested the use of manufacturer representatives. It has
subsequently found that dealers, users and professionals can be provided better
service via direct contact with the in-house sales/customer service
representatives. The Company also utilizes extensive direct mail, trade show
attendance, and trade advertising to promote the benefits of the products to
home care dealers. Additionally, the Company actively seeks to increase
professional awareness of its products through professional advertising and
participation in professional meetings.
Home oxygen therapy markets outside the United States are, in most cases,
at a much earlier stage of development. In many countries, these patients are
cared for in domiciliary settings. As the trend develops to move patients into
home care, opportunities for the Company's products should increase. Sales of
the OXYMATIC conserver in Europe, Canada and Japan have become an important part
of the Company's business. Based on industry market research projections, the
Company expects the market potential to increase to 150% of the U.S. potential
within the current decade.
The Company has entered into exclusive distributorship agreements in
Germany, Canada, Japan, and Australia. The Company's largest distributor in
Germany covers the entire European Community, however, reimbursement pressures
in Germany may limit growth during the upcoming year. The Company also has
non-exclusive distributors in many other countries.
Sales outside of the United States will subject the Company to certain
risks, including those involving political and economic factors, interruption of
shipments of products, currency fluctuations and devaluations and governmental
restrictions and regulations.
Customers, Backlog and Orders
The Company presently has an active list of approximately 4,400 dealer and
hospital customers. Based upon information developed from various lists the
Company believes that there are approximately 7,000 to 8,000 oxygen dealers and
3,000 general
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hospitals in the United States which are potential customers or customer sources
for the Company. Of these 7,000 to 8,000 home oxygen dealers, approximately 30%
are represented by three major national chain accounts. One such national
account, Apria Home Healthcare, accounted for 18% of the Company's revenues in
1997.
Financial Information Relating to Foreign and
Domestic Operations and Export Sales
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -----
<S> <C> <C> <C>
Sales (thousands):
United States $23,567 17,832 12,651
Europe 1,146 961 718
Other 1,448 1,566 1,149
------ ------ ------
Total $26,161 20,359 14,518
======= ====== ======
Gross profit(thousands):
United States $13,509 10,630 6,717
Europe 572 476 340
Other 724 773 545
------ ------ -----
Total $14,805 11,879 7,602
======= ====== =====
</TABLE>
All identifiable assets are located in the United States.
The Company does not presently have, and does not intend in the future to
have, any backlog of orders for any of its products. The Company presently has
and intends to maintain a large enough inventory to ship all of its products
immediately upon receipt of orders. The Company believes that such an inventory
is necessary to meet the requirements of its customers.
Competition
The Company is aware of several demand valve, electronically controlled
devices currently being marketed. Of these devices, those that have been the
principal competitors of the OXYMATIC conserver in the past were targeted
primarily to a specific segment of the market - liquid oxygen usage. Several
companies, including Invacare, Nellcor/Puritan Bennett and Sunrise/De Vilbiss,
market small (5.5 lbs.) portable liquid oxygen systems incorporating simple
oxygen conserving devices which double the useful life of these systems.
Although these units allow longer ambulation and/or reduce the weight of
portable liquid oxygen, they are heavier than the smallest OXYLITE system and
provide less ambulatory time due to the greater efficiency of the OXYMATIC
conserver, which provides at least double the oxygen savings of these
conservers. Also these units are more expensive than OXYLITE systems and still
require the supplier to make frequent and costly oxygen deliveries. The Company
does not know the levels of sales achieved by the companies marketing these
systems.
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Several of these competitors are now marketing combinations of conservers,
regulators and small cylinders in direct competition with the Company's OXYLITE
systems. Many of these products utilize conservers that provide 2:1 to 3:1
savings ratios. As a result, these units while weighing about the same as
similar OXYLITE systems provide only 1/3 or 1/2 of the ambulation time provided
by OXYLITE systems. In addition, the Company is aware of one company which began
marketing an oxygen conserving device in November, 1996, which claims the same
7:1 savings ratio as the OXYMATIC conserver. The Company believes that some of
these competitors have been able to offer their oxygen conservers as part of a
bundle of products with perceived pricing advantges over the Company's products,
however, the Company believes the established reputation of its products for
efficiency and reliability offset these advantages. The Company does not know
the level of sales achieved by these companies.
There are several other types of portable oxygen systems which compete with
the Company's OXYLITE systems but do not utilize oxygen conserving devices.
Aluminum and steel oxygen cylinders with continuous flow are utilized by some
oxygen suppliers as portable systems. Although they do provide users with some
portability, their size and bulk limits their use by patients who need or want
to be truly ambulatory. The most commonly used of these cylinders is
approximately three feet high, weighs over 20 lbs., and provides an average
patient with less than 5 hours of oxygen. The OXYMATIC conserver, which provides
an average oxygen savings of 7 to 1, allows the use of smaller, lighter
cylinders and thus provide greater mobility.
Until the availability of OXYLITE systems and the previously cited changes
in Medicare oxygen reimbursement, liquid oxygen was the modality of choice for
truly mobile users. Portable liquid oxygen systems which weigh 8 to 10 lbs.,
provide an average patient with 6 to 8 hours of oxygen, compared to the smallest
OXYLITE system which weighs 4.5 lbs. and provides an average patient with 10.5
hours of oxygen. These systems are more costly than OXYLITE systems and require
frequent and expensive (usually weekly) deliveries of bulk liquid oxygen to the
patient's home. Although many oxygen suppliers continue to use and re-use
existing inventories of liquid oxygen equipment to service ambulatory patients,
purchases of new liquid oxygen equipment by home care dealers is decreasing.
Patents and Trademarks
The Company regards the products that it develops or licenses and its
manufacturing processes as proprietary and relies on a combination of patents,
trademarks, trade secret laws and confidentiality agreements to protect its
rights in its products. A U.S. patent has been issued covering the original
OXYMIZER device, the OXYMIZER Pendant device and the OXYMATIC conserver. A
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number of foreign patent applications pertaining to the Company's activities
have also been issued.
The Company pursues a policy of obtaining patents for appropriate
inventions related to products marketed or manufactured by the Company. The
Company considers the patentability of products developed for it to be
significant to the success of the Company. To the extent that the products to be
marketed by the Company do not receive patent protection, competitors may be
able to manufacture and market substantially similar products. Such competition
could have an adverse impact upon the Company's business.
There can be no assurance that patents, domestic or foreign, will be
obtained with respect to the Company's products, or that, if issued, they will
provide substantial protection or be of commercial benefit to the Company. In
addition, the patent laws of foreign countries may differ from those of the
United States as to the patentability of the Company's products and processes
and, accordingly, the degree of protection afforded by foreign patents may be
more or less than in the United States.
In the United States, although a patent has a statutory presumption of
validity, the issuance of a patent is not conclusive as to such validity or as
to the enforceable scope of its claims therein. The validity and enforceability
of a patent can be attacked by litigation after its issuance by the U.S. Patent
and Trademark Office. If the outcome of such litigation is adverse to the owner
of the patent in that the patent is held to be invalid, other parties may then
use the invention covered by the patent. Accordingly, there can be no assurance
that patents with respect to the Company's products, if issued, will afford
protection against competitors with similar products, nor can there be any
assurance that the patents will not be infringed upon or designed around by
others.
The Company has obtained U.S. registration for the trademarks "OXYMIZER",
"OXYMATIC", "CHAD" and "OXYCOIL" and has filed an application for the trademark
"OXYFILL". A series of foreign applications to register the trademark "OXYMIZER"
in a number of countries of commercial interest to the Company have been filed.
Governmental Regulation
The commercialization of the OXYMIZER and OXYMATIC devices is subject to
the Federal Food, Drug and Cosmetic Act (the "Food and Drug Act") and to
regulations issued thereunder. The Company anticipates that commercialization of
other devices which it intends to market will also be subject to the Food and
Drug Act. The Food and Drug Act is administered by the FDA, which has authority
to regulate the marketing, manufacturing, labeling,
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packaging and distribution of products subject to the Food and Drug Act. In
addition, there are requirements under other federal laws and under state, local
and foreign statutes which may apply to the manufacture and marketing of the
Company's products. The Medical Device Amendments of 1976 to the Food and Drug
Act (the "Amendments") and the Safe Medical Device Act of 1990 significantly
extended the authority of the FDA to regulate the commercialization of medical
devices. The Amendments established three classifications of medical devices:
Class I, Class II and Class III. With respect to all three classes, the general
provisions of the Food and Drug Act prohibit adulteration and misbranding. A
medical device may be adulterated if the device is or could be adversely
affected by its methods of manufacture, storage or packaging. A medical device
may be misbranded if its labeling is false or misleading or if its labeling does
not contain specific information required by law applicable to such type of
device. In addition, failure to register a medical device covered under the Food
and Drug Act with the FDA will render it misbranded under the Food and Drug Act.
All manufacturers of medical devices must register with the FDA and, with
their initial registration, list all medical devices produced by them. This
listing must be updated annually. In addition, prior to commercial distribution
of additional devices, the manufacturer must file with the FDA and receive
approval prior to the commencement of such commercial distribution, a notice
setting forth certain information about the device, including the classification
into which the manufacturer believes it falls.
Class I devices are subject only to the general controls concerning
adulteration, misbranding, good manufacturing practices, record keeping and
reporting requirements. Class II devices must, in addition, comply with
performance standards as promulgated by the FDA.
The Company has registered with the Bureau of Medical Devices of the FDA as
a Medical Device Establishment and with the Department of Health Services of the
State of California as a Medical Device Manufacturer. In addition, the Company
has developed procedures to comply with FDA standards concerning good
manufacturing practices, record keeping and reporting.
The Company has filed notification submissions pursuant to Section 510(k)
of the Food and Drug Act of its intent to market the OXYMIZER, the OXYMIZER
Pendant, the OXYMATIC conserver and the OXYCOIL; it has been granted permission
by the FDA to market the OXYMIZER and the OXYMIZER Pendant as Class I devices.
Permission has been granted to market the OXYMATIC and the OXYCOIL as Class II
devices.
15
<PAGE> 16
Employees
As of June 13, 1997, CHAD had 90 full-time and no part-time employees.
Forty-nine of the Company's employees are engaged in manufacturing and the
remainder are engaged in marketing, sales, administration and management. None
of the Company's employees are represented by unions; the Company believes its
employee relations are satisfactory. The Company will employ additional
personnel in all phases of its activities as required by the growth in its
activities. The number of additional personnel will be dependent on sales levels
of individual products.
Item 2. Properties.
The Company's principal offices and manufacturing facilities are situated
in premises located in Chatsworth, California and consist of approximately
55,500 square feet, at a monthly rental fee of $24,500 pursuant to a lease
expiring in June, 2003. Management feels this facility should adequately handle
the Company's needs for the foreseeable future. The Company does not own any
real property and does not anticipate acquiring any in the foreseeable future.
Item 3. Legal Proceedings.
The Company may become involved in legal proceedings in the ordinary course
of business. The Company maintains product liability insurance in an amount
deemed customary in the industry for protection of the Company against potential
product liability claims. There are no pending legal proceedings which, in the
opinion of management, would have a material adverse effect on the Company's
financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity and Stockholder Matters.
The information required herein is hereby incorporated by reference to the
information contained under the caption "Corporate Data" in the Company's Annual
Report.
Item 6. Selected Financial Data.
The information required herein is hereby incorporated by reference to the
information contained under the caption "Selected Financial Data" in the
Company's Annual Report.
16
<PAGE> 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
The information required herein is hereby incorporated by reference to the
information contained under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Company's Annual Report.
Item 8. Financial Statements and Supplementary Data.
The information required herein is hereby incorporated by reference to the
Financial Statements and the Notes thereto contained in the Company's Annual
Report.
Item 9. Disagreements on Accounting and Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required herein is hereby incorporated by reference to the
information appearing under the captions "Election of Directors" and "Executive
Officers" in the Company's definitive Proxy Statement to be filed with the
Securities and Exchange Commission.
Item 11. Executive Compensation.
The information required herein is hereby incorporated by reference to the
information appearing under the caption "Compensation of Directors and Executive
Officers" in the Company's definitive Proxy Statement to be filed with the
Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required herein is hereby incorporated by reference to the
information appearing under the caption "Voting Securities and Principal Holders
Thereof" in the Company's definitive Proxy Statement to be filed with the
Securities and Exchange Commission.
Item 13. Certain Relationships and Related Transactions.
None.
17
<PAGE> 18
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) (1) Financial Statements.
Included in Part II of this Report:
Independent Auditors' Report
Balance Sheets -- March 31, 1997 and 1996
Statements of Operations -- Years ended March 31, 1997, 1996
and 1995.
Statements of Shareholders' Equity -- Years ended March 31,
1997, 1996 and 1995.
Statements of Cash Flows -- Years ended March 31, 1997, 1996
and 1995.
Notes to Financial Statements.
(a) (2) Financial Statement Schedules.
None.
(3) Exhibits.
<TABLE>
<S> <C>
3.1 Articles of Incorporation of the Registrant,
as amended*****
3.2 Bylaws of the Registrant, as amended*
10.3 OXYMIZER License Agreement, as amended, with
Robert E. Phillips, Brian L. Tiep, M.D. and
Ben A. Otsap*
10.5 Pulser System License Agreement, as amended,
with Robert E. Phillips, Brian L. Tiep, M.D.
and Ben A. Otsap. (The Pulser System is now
called the OXYMATIC.)*
10.7 OXYMIZER Pendant License Agreement, as
amended, with Robert E. Phillips, Brian L.
Tiep, M.D. and Ben A. Otsap*
10.20 OXYCOIL tubing License Agreement with
Mary Smart (licensed under the name
Respi-Coil).***
</TABLE>
18
<PAGE> 19
<TABLE>
<S> <C>
10.23 Summary plan description for Chad Therapeutics,
Inc. Employee Savings and Retirement Plan****
10.24 1994 Stock Option Plan
10.25 Lease on real property at 21622 Plummer Street,
Chatsworth, California******
13.1 Annual Report to Shareholders for the year
ended March 31, 1997.
23.1 Consent of Independent Accountant
28.1 Letter from the FDA authorizing the Company to market the
OXYMIZER oxygen conserving device as a Class 1 device.*
28.2 Letter from the FDA authorizing the Company to market the
OXYMIZER Pendant oxygen conserving device as a Class 1
device.**
28.5 Letter from the FDA authorizing the Company to market the
OXYMATIC electronic oxygen conserver as a Class 2 device.***
28.6 Letter from the FDA authorizing the Company to market the
OXYCOIL coiled oxygen tubing as a Class 2 device.***
</TABLE>
(b) Reports on Form 8-K - None filed.
(c) Index to Exhibits.
(d) Financial Statement Schedules - None
- --------------
* Previously filed as an Exhibit to the Registrants'
Registration Statement on Form S-18, File No. 2-83926.
** Previously filed as an Exhibit to the Registrants' Annual Report on Form
10-K for the year ended March 31, 1984.
*** Previously filed as an Exhibit to the Registrants' Annual Report on Form
10-K for the year ended March 31, 1986.
**** Previously filed as an Exhibit to the Registrants' Annual Report on Form
10-K for the year ended March 31, 1993.
***** Previously filed as an exhibit to the Registrant's Annual Report on Form
10-K for the year ended March 31, 1994.
****** Previously filed as an exhibit to the Registrant's Annual Report on Form
10-K for the year ended March 31, 1996.
19
<PAGE> 20
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, in the City of Los
Angeles, State of California, on the 20th day of June, 1997.
CHAD THERAPEUTICS, INC.
By /S/Charles R. Adams
---------------------------------------------
Charles R. Adams, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/S/Charles R. Adams Chief Executive June 20, 1997
- ----------------------- Officer and Director
Charles R. Adams (Principal Executive
Officer)
/S/Francis R. Fleming President, Chief June 20, 1997
- ----------------------- Operating Officer and
Francis R. Fleming Director
/S/Earl L. Yager Senior Vice President, June 20, 1997
- ----------------------- Chief Financial
Earl L. Yager Officer and Secretary
and Director (Principal
Financial and Accounting
Officer)
/S/David L. Cutter Director June 20, 1997
- -----------------------
David L. Cutter
/S/John C. Boyd Director June 20, 1997
- -----------------------
John C. Boyd
/S/Norman Cooper Director June 20, 1997
- -----------------------
Norman Cooper
/S/Philip Wolfstein Director June 20, 1997
- -----------------------
Philip Wolfstein
</TABLE>
20
<PAGE> 21
Exhibit Index
Exhibit Index Sequentially
Exhibit No. Document Numbered Page
- ----------- ------------- -------------
13.1 Annual Report to Shareholders for
the year ended March 31, 1997
23.1 Consent of Independent Accountant
<PAGE> 1
EXHIBIT 13.1
[Photograph]
CHAD 1997 Annual Report
THERAPEUTICS
<PAGE> 2
COMPANY OBJECTIVE
(Photograph]
"We will seek to develop and market unique products that perform more
efficiently by reducing costs and improving therapy..."
CHARLES R. ADAMS
2
<PAGE> 3
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA YEARS ENDED MARCH 31,
-------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net Sales $26,161,000 20,359,000 14,518,000 9,470,000 5,805,000
Interest Income 113,000 97,000 50,000 28,000 8,000
Net Earnings 5,035,000 4,310,000 2,606,000 2,053,000 1,237,000
Earnings Per Common Share .49 .42 .26 .20 .12
Net Working Capital 10,985,000 9,219,000 5,172,000 4,176,000 1,943,000
Total Assets 15,861,000 10,778,000 6,371,000 5,075,000 2,635,000
Shareholders' Equity 15,110,000 9,775,000 5,574,000 4,507,000 2,180,000
</TABLE>
No cash dividends have been declared or paid during the periods presented.
TOTAL ASSETS NET EARNINGS PER SHARE
[Graph] [Graph]
SHAREHOLDER'S EQUITY
[Graph]
3
<PAGE> 4
DEAR CHAD SHAREHOLDERS:
It was another good year for CHAD. Again, I am pleased to report to you on our
seventh consecutive year and twenty-eighth consecutive quarter of profitable
growth. The Company continued to work to enhance future growth prospects.
Since the beginning of the Company's successful growth period in fiscal 1990,
sales have multiplied 27.5 times. Earnings before taxes have grown from a loss
of $103,538 to $8,413,000 for fiscal 1997.
The following two charts graphically display the Company's performance for
these years.
The CHAD growth era began soon after the change in June 1989 of Medicare's
method of reimbursement for home oxygen care. Through years of hard work CHAD
was instrumental in effecting this change which reformed and rationalized the
method of reimbursement. These changes encouraged efficiency in the provision
of home oxygen equipment and therapy. As a result, home care dealers now
compete on the basis of the quality and efficiency of their equipment and
service. This new environment created opportunities for CHAD's unique,
cost-savings oxygen conserving products and systems. CHAD continues to provide
the means by which respiratory home care dealers car
[GRAPH]
[PHOTOGRAPH]
CHARLES R. ADAMS
Chairman of the Board and
Chief Executive Officer
4
<PAGE> 5
provide superior service to home oxygen patients. Although a number of factors
(discussed later in this report) converged late in the past year to slow the
Company's rate of growth, the Company still increased domestic sales by 32%
over the prior year.
FINANCIAL HIGHLIGHTS
Complete financial data can be found in the financial section of this report;
however, some of the highlights of the 1997 fiscal year include the following:
Worldwide Sales Increased 29%
U.S. Sales Increased 32%
Pre-Tax Profit Increased 19%
Total Assets Increased 47%
Shareholders' Equity Increased 47%
Return on shareholders' equity for the past fiscal year was 41 percent.
Operating income for the year was 31.8 percent of sales and sales per CHAD
employee were $330,739, a reflection of the Company's continuing productivity.
Total operating expenses as a percent of sales increased only slightly from
24.1 percent to 24.8 percent even though Research and Development expenses grew
from $113,000 to $910,000. Although substantial funds were expended in
constructing the Company's new headquarters and facilities the Company
continues to finance all growth internally from cash flow and has no long term
debt of any kind.
In its November 4, 1996, issue Forbes magazine again selected CHAD in
fourteenth place on its list of the "200 Best Small Companies" - up from
fifteenth place last year. Only one other company repeated in the top fifteen
from the previous year's listing. This recognition followed CHAD's earlier
recognition in May when the Company obtained nineteenth ranking in Business
Week magazine's annual listing of the "Top 100 Growth Companies". This was the
second year in a row that the Company has been recognized by these two
periodicals. Business Week in the May 26, 1997 issue again recognized CHAD with
a third consecutive year listing in thirty-second place.
THE CHANGING AND CHALLENGING MARKETPLACE
During the past year the health care market continued moving toward further
reform, cost containment and cost reduction. The home care portion of the
market has become an especially attractive segment of the market for cost
reduction pressures. Ironically, much of
[GRAPH]
SALES GROWTH
(X $1,000)
5
<PAGE> 6
- -------------------------------------------------------------------------------
LETTER FROM THE CHAIRMAN
- -------------------------------------------------------------------------------
this attention exists because of rapid growth in home care as it has replaced
more expensive hospital care. There seems no doubt that reimbursement
reductions, some possibly drastic, will be imposed on the home care segment. For
the home oxygen portion, reductions seem certain and the Administration's
draconian threat of 40% reduction for oxygen services, while totally
impractical, is still alive as of this writing. These cost pressures over the
past few years have had several effects on our customers and our business.
1. The rapid increase in managed care has forced home oxygen services providers
to bid for these managed care contracts primarily on a lowest cost basis. In
many cases they supply only the very least expensive means of meeting patient's
oxygen requirements. In many cases this means the cheapest oxygen concentrator
and a large compressed oxygen cylinder for "portability" and in some cases
patients are now personally responsible for exchanging of oxygen cylinders for
refills.
2. Cost pressures have forced dealers into consolidation with major chain
operations that continue acquiring independent operators at a rapid rate. These
large chains have great buying power and force reduced prices from their
contract suppliers. Chains now include approximately eighteen percent of the
home care dealers, and service approximately thirty percent of the home oxygen
patients.
3. Competition has become intense. CHAD's oxygen conserving devices over the
years have represented an excellent tool for dealers to cope with reduced
reimbursement for oxygen services. Naturally, this edge was certain to attract
competition. For several years there have been numerous competitors to the
Company's products but none of them offered the efficiency of the CHAD products.
During the last seven months of the past fiscal year at least three major
companies entered the market with new devices, different technologies and
designs and very strong sales and pricing efforts.
All of these factors have had an impact on the Company's growth. The first two
quarters of the new fiscal year will continue to be difficult and challenging
for the Company as we move through a transition phase. The Company's OXYMATIC
technology and resulting products are now more than ten years old and have
served and will continue to serve the Company well. While it is difficult to
predict the exact timing for the introduction of a new product, management
expects that by the third quarter of the year new proprietary technology could
be adding substantially to our growth.
GROWING A STRONGER CHAD
The Company plans to grow and strengthen during the upcoming fiscal year and,
most likely, for several years to come by:
1. DEVELOPING NEW AND UNIQUE PRODUCTS THAT WILL REDUCE COSTS WHILE MAINTAINING
THERAPEUTIC EFFICACY.
This has been a stated CHAD objective since the Company's founding in
[PHOTOGRAPH]
OSCAR J. SANCHEZ
Vice President
Development and Engineering
6
<PAGE> 7
1982. However, the objective has been difficult to achieve because truly new
and unique products in home respiratory care are very rare. At CHAD we feel
that our future must be built on truly unique products. The Company does not
have or intend to have in the foreseeable future a dedicated outside sales
force with all the attendant costs. This would be essential in the marketing of
products that are only versions or modest improvements of existing products.
Management believes that the Company's next product, which is now in the hands
of the Food and Drug Administration, is not only new and unique but represents
a revolution in home oxygen therapy and may well be the most significant
advance in a decade. Management has chosen not to reveal full details of the
TOTAL O(2)(TM) until the FDA has responded to our application. However, current
expectations are that this product should be marketed in the fall of this year.
This product is very much in keeping with our growth objective.
Although CHAD's expenditures for Research and Development have been relatively
small, the Company hopes to soon begin work on additional products with our
development partner, Litton Life Support Systems. This has been a very
effective and productive relationship. Additionally, the Internal Development
and Engineering effort has been reorganized under Oscar Sanchez as Vice
President. Mr. Sanchez is an original CHAD employee and formerly served as Vice
President Manufacturing. Several projects are currently in development for the
medium range including an improved OXYMATIC conserver and a new and even more
efficient electronic conserver. The Company is also investigating two
completely new technologies that could produce new lines of products in the
respiratory field.
2. CONTINUING TO EARN OUR CUSTOMERS LOYALTY BY BEING THEIR PARTNER, HELPING
THEM GROW THEIR BUSINESS AND PROVIDING PRODUCTS THAT IMPROVE THE QUALITY OF
LIFE FOR THEIR PATIENTS.
CHAD has grown in the past by working closely with our customers to meet their
needs and helping them to remain profitable even with decreasing revenues as a
result of diminishing reimbursement. CHAD believes that we can grow only as we
provide cost saving, user friendly products that satisfy patients,
professionals and home care dealers alike.
3. EXPANDING INTERNATIONALLY THROUGH REORGANIZATION OF OUR EFFORTS AND MAKING
INTERNATIONAL SALES A MUCH LARGER PERCENTAGE OF OUR BUSINESS BY FISCAL YEAR
2000.
The Company will begin re-evaluating our international structure this summer
with the objective of having a stronger infrastructure in place and operating
in time for an effective international launch of the TOTAL O(2)(TM) product by
the next fiscal year.
The Company's international growth until now has been hampered by a single
product line and only a few capable distributors in the respiratory care field.
Further, home respiratory care is a reality in only the most developed
countries. Management and our consultants believe that CHAD's new product may
well open up entirely new markets to home respiratory care due to its
revolutionary concept and technology.
7
<PAGE> 8
IMPROVING PRODUCTIVITY
The Company has continually improved productivity and the past year was a
landmark. In the Fall of 1996 CHAD moved into new larger and more efficiently
organized facilities with the very latest in modern production and testing
capability. This major move was accomplished without disruption in service to
our customers. We are very proud of the quality of our operations and our
employees.
The cost of making our products has continued to decline with the
internalization of our production. While we presently have room for considerable
growth in the production of the existing product lines, we believe that
additional manufacturing and warehousing space and possibly remote distribution
facilities may be necessary with the success of the TOTAL O(2)(TM) product line.
Mr. Alfonso Del Toro joined CHAD as Manufacturing Manager in January 1997. Mr.
Del Toro came to CHAD after fourteen years of medical products manufacturing
management. He received his degree in Engineering from The Cd. Guzman Institute
of Technology in Jalisco, Mexico and earned his Masters degree from Purdue
University in Indiana. He will continue to improve our productivity on the
existing product line while directing the efforts toward production of new
products.
OUTLOOK FOR FUTURE
This is a challenging time for everyone at CHAD as we work through the current
competitive wars and try to ready ourselves for the next phase. As anyone who
has visited CHAD and knows the people would expect, they are undaunted. This
experience will make everyone better - battle hardened and experienced. Morale
is high and everyone at CHAD is looking forward to the coming year.
On behalf of CHAD's management and the Board of Directors, thank you once
[PHOTOGRAPH]
ALFONSO DEL TORO
Manufacturing Manager
8
<PAGE> 9
[Photograph]
CHAD SENIOR MANAGEMENT
From Left to Right: Francis R. Fleming, President and Chief Operating Officer;
Charles R. Adams, Chief Executive Officer; and Earl L. Yager,
Senior Vice President, Chief Financial Officer and Secretary.
again for your loyalty, confidence and continued support. Once again I promise
that we will do our very best.
/s/ CHARLES R. ADAMS
Charles R. Adams
Chairman of the Board of Directors
and Chief Executive Officer
9
<PAGE> 10
BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
----------------------------------
ASSETS 1997 1996
----------- ----------
<S> <C> <C>
Current assets: $ 2,289,000 1,809,000
Cash -- 1,029,000
Marketable securities
Accounts receivable, less allowance for doubtful accounts of
$107,000 and $92,000 in 1997 and 1996 2,329,000 2,872,000
Inventories (Note 2) 6,063,000 4,011,000
Income taxes refundable (Note 3) 527,000 --
Prepaid expenses 172,000 145,000
Deferred income taxes (Note 3) 356,000 356,000
----------- ----------
Total current assets 11,736,000 10,222,000
----------- ----------
Property and equipment, at cost:
Office equipment and furniture 1,265,000 478,000
Machinery and equipment 634,000 192,000
Tooling 305,000 303,000
Leasehold improvements 1,640,000 101,000
----------- ----------
3,844,000 1,074,000
Less accumulated depreciation and amortization 717,000 574,000
----------- ----------
Net property and equipment 3,127,000 500,000
----------- ----------
Other assets, net (Note 4) 998,000 56,000
----------- ----------
$15,861,000 10,778,000
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996
----------- ----------
Current liabilities:
Accounts payable $ 344,000 399,000
Accrued expenses 407,000 424,000
Income taxes payable (Note 3) -- 180,000
----------- ----------
Total current liabilities 751,000 1,003,000
----------- ----------
Commitments (Note 7)
Shareholders' equity (Note 5):
Common shares
Authorized 40,000,000 shares;
9,951,000 and 9,623,000 shares issued 12,834,000 6,791,000
Retained earnings 2,308,000 3,052,000
----------- ----------
15,142,000 9,843,000
Less treasury shares at cost, 3,000 and 5,000 shares in 1997 and 1996 (32,000) (68,000)
----------- ----------
Net shareholders' equity 15,110,000 9,775,000
----------- ----------
$15,861,000 10,778,000
=========== ==========
</TABLE>
See accompanying notes to financial statements.
10
<PAGE> 11
STATEMENT OF EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------------------
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Net sales $26,161,000 20,359,000 14,518,000
Cost of sales 11,356,000 8,480,000 6,916,000
----------- ---------- ----------
Gross profit 14,805,000 11,879,000 7,602,000
Costs and expenses:
Selling, general and administrative 5,595,000 4,791,000 3,777,000
Research and development 910,000 113,000 70,000
----------- ---------- ----------
Total costs and expenses 6,505,000 4,904,000 3,847,000
----------- ---------- ----------
Operating income 8,300,000 6,975,000 3,755,000
Interest income 113,000 97,000 50,000
----------- ---------- ----------
Earnings before income taxes 8,413,000 7,072,000 3,805,000
Income taxes (Note 3) 3,378,000 2,762,000 1,199,000
----------- ---------- ----------
Net earnings $ 5,035,000 4,310,000 2,606,000
=========== ========== ==========
Net earnings per share $ .49 .42 .26
=========== ========== ==========
Weighted average number of common shares
and common share equivalents 10,373,000 10,220,000 10,169,000
=========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
11
<PAGE> 12
STATEMENTS OF SHAREHOLDER'S EQUITY
FOR THE YEARS ENDED MARCH 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
RETAINED
COMMON SHARES (NOTE 4) EARNINGS
------------------------- (ACCUMULATED TREASURY
SHARES AMOUNT DEFICIT) SHARES
--------- ------------ ----------- ---------
<S> <C> <C> <C> <C>
Balance at March 31, 1994 9,438,000 $ 5,875,000 $(1,340,000) $ (28,000)
Common Shares Issued For Purchases
Under Employee Benefit Plan (Note 5) -- 44,000 -- 28,000
Common Shares Repurchased and Retired (307,000) (1,675,000) -- --
5% Stock Dividend 459,000 2,524,000 (2,524,000) --
Exercise of Stock Options 30,000 23,000 -- --
Tax Benefit From Exercise of
Non-Qualified Stock Options (Note 5) -- 41,000 -- --
Net Earnings -- -- 2,606,000 --
--------- ------------ ----------- ---------
Balance at March 31, 1995 9,620,000 6,832,000 (1,258,000) --
Common Shares Repurchased and Retired (71,000) (392,000) -- --
Common Shares Repurchased At Cost -- -- -- (228,000)
Common Shares Issued For Purchases
Under Employee Benefit Plan (Note 5) -- -- -- 160,000
Exercise of Stock Options 74,000 187,000 -- --
Tax Benefit From Exercise of
Non-Qualified Stock Options (Note 5) -- 164,000 -- --
Net Earnings -- -- 4,310,000 --
--------- ------------ ----------- ---------
Balance at March 31, 1996 9,623,000 6,791,000 3,052,000 (68,000)
Common Shares Repurchased At Cost -- -- -- (183,000)
Common Shares Issued For Purchases
Under Employee Benefit Plan (Note 5) -- 5,000 -- 219,000
3% Stock Dividend 289,000 5,779,000 (5,779,000) --
Exercise of Stock Options 41,000 216,000 -- --
Common Shares Tendered and Retired
For Stock Option Exercise (2,000) (32,000) -- --
Tax Benefit From Exercise of
Non-Qualified Stock Options (Note 5) -- 75,000 -- --
Net Earnings -- -- 5,035,000 --
--------- ------------ ----------- ---------
Balance at March 31, 1997 9,951,000 $ 12,834,000 $ 2,308,000 $ (32,000)
========= ============ =========== =========
</TABLE>
See accompanying notes to financial statements.
12
<PAGE> 13
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN CASH
YEARS ENDED MARCH 31,
------------------------------------------
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 5,035,000 4,310,000 2,606,000
Adjustments to reconcile net earnings
to net cash provided by operating activities:
Depreciation and amortization 280,000 114,000 88,000
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 543,000 (746,000) (696,000)
Decrease (increase) in inventories (2,052,000) (2,166,000) (685,000)
Decrease (increase) in income taxes refundable (527,000) 84,000 (27,000)
Decrease (increase) in prepaid expenses (27,000) (20,000) (59,000)
Decrease (increase) in deferred income taxes -- (202,000) (154,000)
Decrease (increase) in other assets (942,000) -- (21,000)
Increase (decrease) in accounts payable (55,000) (115,000) 230,000
Increase (decrease) in accrued expenses (17,000) 141,000 5,000
Increase (decrease) in income taxes payable (105,000) 344,000 35,000
----------- ---------- ----------
Net cash provided by operating activities 2,133,000 1,744,000 1,322,000
----------- ---------- ----------
Cash flows from investing activities:
Decrease (increase) in marketable securities 1,029,000 (613,000) (416,000)
Capital expenditures (2,912,000) (268,000) (138,000)
Dispositions of property and equipment 5,000 -- --
----------- ---------- ----------
Net cash (used in) investing activities (1,878,000) (881,000) (554,000)
----------- ---------- ----------
Cash flows from financing activities:
Exercise of stock options 216,000 187,000 23,000
Common shares purchased (183,000) (620,000) (1,675,000)
Common shares issued 224,000 160,000 72,000
Common shares tendered and retired (32,000) -- --
----------- ---------- ----------
Net cash provided by (used in) financing activities 225,000 (273,000) (1,580,000)
----------- ---------- ----------
Net increase (decrease) in cash 480,000 590,000 (812,000)
Cash beginning of year 1,809,000 1,219,000 2,031,000
----------- ---------- ----------
Cash end of year $ 2,289,000 1,809,000 1,219,000
=========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $ 4,010,000 2,535,000 1,342,000
=========== ========== ==========
Supplemental schedule of noncash investing
and financing activities:
Common stock issued as payment of dividend $ 5,799,000 -- 2,524,000
Tax benefit from exercise of non-qualified stock options $ 75,000 164,000 41,000
=========== ========== ==========
</TABLE>
13
<PAGE> 14
N O T E S T O F I N A N C E
MARCH 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Chad Therapeutics, Inc. (the Company) is in the business of developing,
producing and marketing respiratory care devices designed to improve the
efficiency of oxygen delivery systems for home health care and hospital
treatment of patients suffering from pulmonary diseases.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carry amounts of financial instruments approximate fair value as of
March 31, 1997. The carrying amounts related to cash, accounts receivable,
other current assets, accounts payable and accrued expenses approximate fair
value due to the relatively short maturity of such instruments.
INVENTORIES
Inventories are valued at lower of cost (first-in, first-out) or market.
DEPRECIATION
Depreciation of property and equipment is provided using straight-line methods
based on the estimated useful lives of the related assets as follows:
Office Equipment and Furniture 5-10 Years
Machinery and Equipment 5-10 Years
Tooling 3-7 Years
Amortization of leasehold improvement is over the life of the related lease or
asset, whichever is shorter.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the balance sheet date and the reporting
of revenues and expenses during the periods to prepare these financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment of merchandise.
NET EARNINGS PER COMMON SHARE
The net earnings per common share is based upon the weighted average number of
shares and common stock equivalents outstanding during the period. All of the
share, per share and weighted average number of shares have been retroactively
adjusted for a three-for-two stock split distributed on October 16, 1995, to
all shareholders of record on October 2, 1995. In addition, the weighted average
number of shares has been adjusted for a 5% stock dividend paid on October 21,
1994, to shareholders of record on October 7, 1994, which resulted in the
issuance of 459,000 new shares and a 3% stock dividend paid on October 15, 1996,
to shareholders of record on October 1, 1996, which resulted in the issuance of
289,000 new shares.
RESEARCH AND DEVELOPMENT COSTS
The Company charges all research and development costs to expense when
incurred.
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in
14
<PAGE> 15
the years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enacted date.
MAJOR CUSTOMER
The Company had sales to one major customer which accounted for approximately
18% of net sales during the year ended March 31, 1997. No one customer exceeded
10% of net sales during 1996 or 1995.
MARKETABLE SECURITIES
The Company classifies its investments, comprised principally of highly liquid
debt instruments with maturities greater than 90 days, as available-for-sale
securities. Available-for-sale securities are reported at fair values, which
approximates cost and the related unrealized gain or loss is included in
shareholders' equity.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year's balances to conform
to the 1996 presentation.
STOCK OPTION PLAN
In October, 1995, Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("Statement No. 123"), was issued.
This statement encourages, but does not require, a fair value based method of
accounting for employee stock options and will be effective for fiscal years
beginning after December 15, 1995. The Company elected to continue to measure
compensation costs under APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and to comply with the pro forma disclosure requirements of
Statement No. 123 and thus, Statement No. 123 had no effect on the Company's
financial statements.
(2) INVENTORIES
At March 31, 1997 and 1996, inventories consisted of the following:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
Finished goods $1,228,000 787,000
Work in process 1,454,000 1,532,000
Raw materials and supplies 3,381,000 1,692,000
---------- ---------
$6,063,000 4,011,000
---------- ----------
</TABLE>
(3) INCOME TAXES
The provision for income taxes for fiscal 1997, 1996 and 1995 consists of the
following:
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- ---------
<S> <C> <C> <C>
Current:
Federal $2,609,000 2,288,000 967,000
State 769,000 676,000 345,000
---------- --------- ---------
3,378,000 2,964,000 1,312,000
Deferred:
Federal (10,000) (181,000) (122,000)
State 10,000 (21,000) 9,000
---------- --------- ---------
-- (202,000) (113,000)
---------- --------- ---------
Total $3,378,000 2,762,000 1,199,000
========== ========= =========
</TABLE>
A reconciliation of the difference between the Company's provision for income
taxes and the statutory income taxes for the years ended March 31, 1997, 1996
and 1995, respectively, is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------- --------- ---------
<S> <C> <C> <C>
Statutory tax expense $2,860,000 2,404,000 1,294,000
Benefit of net carry
forward position -- -- (243,000)
State income tax 514,000 432,000 234,000
Warranty and other 4,000 (74,000) (86,000)
---------- --------- ---------
$3,378,000 2,762,000 1,199,000
========== ========= =========
</TABLE>
15
<PAGE> 16
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at March 31, 1997 and 1996 are presented as follows:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
State income taxes $265,000 222,000
Other 91,000 134,000
-------- -------
Total gross deferred
tax assets 356,000 356,000
Less valuation allowance -- --
-------- -------
Net deferred tax assets $356,000 356,000
======== =======
</TABLE>
(4) OTHER ASSETS
Other assets includes $950,000 paid in 1997 for a license on a new product. The
license fee will be amortized beginning in 1988 using the straight-line method
over the life of the related patents, 17 years.
(5) SHAREHOLDERS' EQUITY
In 1997 and 1995 the Company purchased its own stock for purposes of funding
contributions to the Company's 401(k) plan. Periodically as common shares are
sold to the plan, the difference between the cost and fair market value at the
date of transfer is credited to shareholders' equity ($5,000 in 1997 and
$44,000 in 1995).
The Company has an incentive stock option plan (the Plan) for key employees as
defined under Section 422(A) of the Internal Revenue Code. The Plan as amended,
provides that 1,509,000 common shares be reserved for issuance under the Plan,
which expires on September 10, 2004. In addition, the Plan provides that
non-qualified options can be granted to directors and independent contractors of
the Company. Transactions involving the stock option plan are summarized as
follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTION OPTION PRICE
SHARES AMOUNT PER SHARE
------- ---------- ---------
<S> <C> <C> <C>
Incentive Options:
Outstanding - March 31, 1994 126,000 $ 246,000 1.95
Granted 397,000 2,308,000 5.81
Exercised (11,000) (18,000) 1.64
------- ---------- -----
Outstanding - March 31, 1995 512,000 2,536,000 4.95
Granted 134,000 1,520,000 11.34
Exercised (38,000) (89,000) 2.34
------- ---------- -----
Outstanding - March 31, 1996 608,000 3,967,000 6.53
Cancelled (15,000) (117,000) 7.80
Granted -- -- --
Exercised (27,000) (153,000) 5.67
------- ---------- -----
Outstanding - March 31, 1997 566,000 $3,697,000 6.53
======= ========== =====
Exercisable - March 31, 1997 264,000 $1,384,000 5.24
======= ========== =====
Non-qualified Options:
Outstanding - March 31, 1994 164,000 $ 450,000 2.74
Granted 15,000 18,000 5.06
Exercised (19,000) (5,000) .26
------- ---------- -----
Outstanding - March 31, 1995 160,000 526,000 3.29
Granted 62,000 775,000 12.50
Exercised (39,000) (98,000) 2.51
------- ---------- -----
Outstanding - March 31, 1996 183,000 1,203,000 6.57
Cancelled (3,000) (11,000) 3.93
Granted 16,000 139,000 9.25
Exercised (14,000) (64,000) 4.57
------- ---------- -----
Outstanding - March 31, 1997 182,000 $1,267,000 6.96
======= ========== =====
Exercisable - March 31, 1997 127,000 $ 693,000 5.46
======= ========== =====
</TABLE>
At March 31, 1997, the range of exercise prices and weighted average remaining
contractual life of outstanding options was $1.68 to $13.47 and 7.5 years,
respectively.
Incentive and non-qualified options were granted at prices not less than 100%
of fair market value at dates of grant. Options under the plan become
exercisable on the anniversary of the
16
<PAGE> 17
grant date on a prorata basis over a defined period and expire 10 years after
the date of grant. To the extent the Company derived a tax benefit from options
exercised by employees, such benefit is credited to Common Stock when realized
on the Company's income tax returns.
The Company applies Accounting Principles Board Opinion No. 25 in accounting
for its plan. Accordingly, no compensation expense has been recognized for its
stock options in the accompanying financial statements. Had compensation cost
for awards under the Company's stock option plan been determined based upon the
fair value at the grant date prescribed under Statement of Financial Accounting
Standards No. 123, the Company's net earnings in 1997, 1996 and 1995 would have
been reduced by approximately $351,000, $239,000 and $18,000 respectively, and
net earnings per share would have been reduced by $.03, $.02 and $.00 per share
in 1997, 1996 and 1995, respectively. The weighted average fair value of options
granted during 1997, 1996 and 1995 is estimated at $2.83, $5.69 and $4.41
respectively. The fair value of options granted during each period was estimated
using the Black-Scholes option pricing model with the following assumptions:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Risk-free interest rate 5.9% 6.2% 6.8%
Forfeiture rate 2.0% 2.0% 2.0%
Dividend yield .0 .0 .0
Volatility 45% 45% 45%
Expected life (years) 5% 5% 5%
</TABLE>
(6) EMPLOYEE BENEFIT PLAN
In December, 1992, the Company adopted a defined contribution profit sharing
plan, including features under Section 401(k) of the Internal Revenue Code. The
purpose of the plan is to provide an incentive for employees to make regular
savings for their retirement. Company contributions to the profit sharing plan
are discretionary and are determined by the Board of Directors.
The Company has accrued and paid $96,000, $71,000, and $48,000 of the plan
contributions during 1997, 1996 and 1995, respectively.
(7) COMMITMENTS
The Company is currently leasing its administrative and plan facilities and
certain office equipment under noncancellable operating leases which expire
through June, 2003.
The Company's minimum annual rental commitments under these leases are as
follows:
<TABLE>
<S> <C>
1998 $ 354,000
1999 362,000
2000 348,000
2001 341,000
2002 354,000
Thereafter 461,000
----------
TOTAL: $2,220,000
==========
</TABLE>
Rent expense amounted to $417,000, $239,000, and $192,000 for the years ended
March 31, 1997, 1996 and 1995, respectively.
(8) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents summarized unaudited quarterly financial data for
1997 and 1996:
<TABLE>
<CAPTION>
Gross Net Net Earnings
Revenue Profit Earnings Per Share
----------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
1997
- ----
First Quarter $ 7,772,000 $ 4,593,000 $1,624,000 $0.16
Second Quarter 7,357,000 4,257,000 1,610,000 0.15
Third Quarter 5,955,000 3,161,000 1,099,000 0.11
Fourth Quarter 5,077,000 2,794,000 702,000 0.07
----------- ----------- ---------- -----
Year $26,161,000 $14,805,000 $5,035,000 $0.49
=========== =========== ========== =====
1996
- ----
First Quarter $ 5,283,000 $ 2,930,000 $ 995,000 $0.10
Second Quarter 5,264,000 3,079,000 1,021,000 0.10
Third Quarter 4,641,000 2,637,000 940,000 0.09
Fourth Quarter 5,171,000 3,233,000 1,394,000 0.13
----------- ----------- ---------- -----
Year $20,359,000 $11,879,000 $4,310,000 $0.42
=========== =========== ========== =====
</TABLE>
17
<PAGE> 18
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
Chad Therapeutics, Inc.
We have audited the accompanying balance sheets of Chad Therapeutics, Inc. as
of March 31, 1997 and 1996 and the related statements of earnings,
shareholders' equity and cash flows for the three years ended March 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Chad Therapeutics, Inc. as of
March 31, 1997 and 1996 and the results of its operations and its cash flows
for the three years ended March 31, 1997, in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
Los Angeles, California
May 10, 1997
18
<PAGE> 19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Sales for the years ended March 31, 1997 and 1996, increased $5,802,000 and
$5,841,000 or 28.5% and 40.2%, respectively, over the prior year's periods.
There were no price increases during the periods presented. The increase in
sales relates primarily to increases in domestic sales of OXYMATIC conservers
and OXYLITE complete portable oxygen systems which are benefiting from the
current marketing environment for home oxygen therapy discussed below.
Sales to foreign distributors represented 9.9% and 12.4% of total sales for the
years ended March 31, 1997 and 1996, respectively, as these sales increased at
a slower rate than domestic sales. Currently, management expects a smaller
increase in sales to foreign distributors during the upcoming fiscal year and
while these sales should continue to increase on an annual basis, quarter to
quarter sales will fluctuate depending on the timing of shipments. In addition,
all foreign sales are transacted in dollars, thus quarter to quarter unit sales
could be affected by foreign currency fluctuations.
In June, 1989, a new procedure for payment by Medicare for home oxygen services
became effective which provides a prospective flat fee monthly payment based
solely on the patient's prescribed oxygen requirement. Previously dealers were
reimbursed on the basis of total oxygen delivered and a rental charge which
varied based on the type of system being used and other factors. The prior
procedure tended to encourage waste and inefficiency. Consequently, with the
incentive now to operate efficiently, inexpensive concentrators have grown in
popularity because of low cost and less frequent servicing requirements. At the
same time, interest heightened in oxygen conserving devices which can extend
the life of oxygen supplies and reduce service calls by dealers. Management
believes the new reimbursement procedures have heightened interest in the cost
savings and increased mobility afforded by oxygen conserving devices such as
the Company's products.
In addition, other changes in the health care delivery system - including the
increase in the acceptance and utilization of managed care - have stimulated a
significant consolidation among home oxygen dealers. As major national and
regional home medical equipment chains attempt to secure managed care contracts
and improve their market position, they have expanded their distribution
networks through the acquisition of independent dealers in strategic areas. In
1997, three major national chains accounted for approximately 31% of the
Company's domestic sales. This percentage is approximately equal to these
chains' total market share in the home oxygen business. Margins on these sales
may be somewhat lower due to quantity pricing. The Company's products, which
allow homecare dealers to provide cost efficient home oxygen therapy, are
ideally suited for use in a managed care environment and as a tool for dealers
to increase revenues and profits. To ensure continued awareness of the benefits
of the Company's products by chain headquarters personnel, a proactive marketing
and communication program is in effect with all of the major national chains.
The Company believes that its rate of growth at the end of fiscal 1997 was
adversely affected by several factors. During the quarter ended March 31, 1997,
sales to national chain accounts decreased as programs to convert patients to
more cost efficient systems in the previous year's quarter did not recur. In
addition, sales to national chain accounts as well as independent dealers have
also been impacted by increased competitive factors and uncertainties regarding
the size of potential cuts in Medicare home oxygen reimbursement which are being
discussed as part of the Federal budget process. Management believes these
factors will continue to affect the Company's rate of sales growth and level of
profitability for at least the first half of the year ending March 31, 1998.
Cost of sales as a percent of net sales increased from 41.7% to 43.4% and
decreased from 47.6% to 41.7%, respectively, for the years ended March 31, 1997
and 1996, as compared to the prior year's periods. The cur-
19
<PAGE> 20
rent year has been affected by higher fixed overhead costs related to the
Company's move to new facilities in October. The decrease in cost of sales
percentage in the prior year related to decreased production costs related to
bringing certain manufacturing operations in house. Management believes gross
margins may decline in the near future due to increased competition.
Selling, general and administrative expenditures decreased as a percentage of
net sales for the years ended March 31, 1997 and 1996, from 23.5% to 21.4% and
from 26.0% to 23.5%, respectively, as compared to the prior year's periods, as
the rate of growth in sales exceeded the increased costs associated with such
growth. Research and development expenses increased by $797,000 and $43,000 for
the years ended March 31, 1997 and 1996, respectively, as compared to the prior
year's periods. Currently, management expects research and development
expenditures to total approximately $950,000 in the fiscal year ending March
31, 1998, on projects to enhance and expand the Company's product line.
At March 31, 1995, the Company had fully utilized its net operating loss
carryforwards for Federal income tax purposes and other tax credit
carryforwards. Future years will therefore be fully taxed and management
estimates that the combined Federal and California income tax rates will be
approximately 40%, as compared to 40.1% in 1997, 39.1% in 1996 and 31.5% in
1995.
FINANCIAL CONDITION
At March 31, 1997, the Company had cash and marketable securities totaling
$2,289,000 or 14% of total assets, as compared to $2,838,000 (26%) at March 31,
1996. Approximately $2,900,000 has been expended during the year ended March
31, 1997, for capital expenditures associated with the construction of the
Company's new corporate headquarters and related additions. Net working capital
increased from $9,219,000 at March 31, 1996 to $10,985,000 at March 31, 1997.
Accounts receivable decreased $543,000 during the period ended March 31, 1997,
which related to a decrease in sales to international customers during the
quarter ended March 31, 1997. Future increases or decreases in accounts
receivable will generally coincide with sales volume fluctuations and the
timing of shipments to foreign customers. During the same period, inventories
increased $2,052,000. The Company attempts to maintain sufficient inventories
to meet its customer needs as orders are received. Thus, future inventory and
related accounts payable levels will be impacted by the ability of the Company
to maintain its safety stock levels. If safety stock levels drop below target
amounts then inventories in subsequent periods will increase more rapidly as
inventory balances are replenished.
Management believes funds derived from operations should be adequate to meet
the Company's present cash requirements. The Company does not have any
established external sources of funds. The Company expects capital expenditures
during the next twelve months to be approximately $1,250,000. On June 30, 1994,
the Company announced that the Board of Directors had authorized stock
repurchases of its common shares in privately negotiated transactions for a
minimum of 10,000 shares. While the Company made no stock repurchases during
the year ended March 31, 1997, the Company may make additional stock
repurchases pursuant to the Board of Directors authorization in the future. In
addition, the Board has authorized the Company to purchase shares of the
Company's common stock in open market transaction. During the year ended March
31, 1997, the Company purchased approximately 15,000 shares at a cost of
$183,000, however, the number of shares which may be purchased under these
programs in the future can be predicted at this time. The Company does not
provide post employment retirement benefits.
NEWLY ISSUED ACCOUNTING STANDARDS
In March, 1995, Statement of Financial Accounting Standards No. 121, Accounting
for the Impairment of
20
<PAGE> 21
Long-lives Assets and for Long-lived Assets to be disposed of was issued. This
statement provides guidelines for recognition of impairment losses related to
long-term assets and is effective for fiscal years beginning after December 15,
1995. The adoption of this new standard did not have a material effect on the
Company's financial statements.
In October, 1995, Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation" ("Statement No. 123"), was issued.
This statement encourages, but does not require, a fair value based method of
accounting for employee stock options and is effective for fiscal years
beginning after December 15, 1995. The Company will continue to measure
compensation costs under APB Opinion No. 25, Accounting for Stock Issued to
Employees and complied with the pro forma disclosure requirements of Statement
No. 123 in its annual financial statements.
The Financial Accounting Standards Board issued Statement No. 128, "Earnings
per Share" ("FAS 128"), in February 1997. FAS 128 is effective for both interim
and annual periods ending after December 15, 1997. The Company will adopt FAS
128 in the third quarter of 1998. FAS 128 requires the presentation of
"Basic" earnings per share which represents income available to common
shareholders divided by the weighted average number of common shares
outstanding for the period. A dual presentation of "Diluted" earnings per share
will also be required. The Diluted presentation is similar to the current
presentation of all prior-period earnings per share data presented. Management
believes the adoption of FAS 128 will not have a material impact on the
Company's financial position or results of operations.
OUTLOOK: ISSUES & RISKS
This annual report contains forward-looking statements which reflect the
Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties which may cause actual operating results to differ materially
from currently anticipated results. Among the factors that could cause actual
results to differ materially are the following:
DEPENDENCE UPON A SINGLE PRODUCT LINE
Although the Company currently markets a number of products, these products
comprise a single product line for patients requiring supplementary oxygen. The
Company's future performance is thus dependent upon developments affecting this
segment of the health care market and the Company's ability to remain
competitive within this market sector.
CONSOLIDATION OF HOME CARE INDUSTRY
The home health care industry is undergoing significant consolidation. As a
result, the market for the Company's products is increasingly influenced by
major national chains. Three major national chains presently account for 31% of
the Company's domestic sales. Future sales may be increasingly dependent on a
limited number of customers which may have an impact on margins due to
quantity pricing.
COMPETITION
Chad's success over the past several years has drawn new competition to vie
for a share of the home oxygen market. These new competitors include both small
and very large companies. The Company believes the quality of its products and
its established reputation will continue to be a competitive advantage;
however, no assurance can be given that increased competition in the home
oxygen market will not have an adverse affect on the Company's product pricing
and operations.
RAPID TECHNOLOGICAL CHANGE
The health care industry is characterized by rapid technological change. The
Company's products may become obsolete as a result of new developments. The
Company's ability to remain competitive will depend to a large extent upon its
ability to anticipate and stay abreast of new technological developments
related to oxygen therapy. The Company has limited
21
<PAGE> 22
internal research and development capabilities. Historically, the Company has
contracted with outside parties to develop new products. Some of the Company's
competitors have substantially greater funds and facilities to pursue research
and development of new products and technologies for oxygen therapy.
POTENTIAL CHANGES IN ADMINISTRATION OF HEALTH CARE
A number of bills proposing to regulate, control or alter the method of
financing health care costs have been discussed and certain of such bills have
been introduced in Congress and various state legislatures. There are wide
variations among these bills and proposals. Because of the uncertain state of
the health care proposals, it is not possible at this time to predict the
effect on the business of the Company if any of these proposals is enacted.
Federal law has altered the payment rates available to providers of Medicare
services in various ways during the last several years. Congress has passed
legislation which would reduce Medicare spending. Some of the savings are to
come from increases in premiums to cover part of the Medicare program cost. It
cannot be predicted, however, what prospective payment system rates or rule
changes will be made to determine how rates will be affected. There can be no
assurance that a change in Medicare reimbursement rates will not have an
adverse effect on the Company's business.
PATENTS AND TRADEMARKS
The Company pursues a policy of obtaining patents for appropriate inventions
related to products marketed or manufactured by the Company. The Company
considers the patentability of its products to be significant to the success of
the Company. To the extent that the products to be marketed by the Company do
not receive patent protection, competitors may be able to manufacture and
market substantially similar products. Such competition could have an adverse
impact upon the Company's business.
PRODUCTS LIABILITY
The nature of the Company's business subjects it to potential legal actions
asserting that the Company is liable for damages for product liability claims.
Although the Company maintains products liability insurance in an amount which
it believes to be customary in the industry, there is no assurance that this
insurance will be sufficient to cover the costs of defense or judgments which
might be entered against the Company. The type and frequency of these claims
could have an adverse impact on the Company's results of operations and
financial position.
AVAILABILITY OF THIRD PARTY COMPONENT PRODUCTS
The Company tests and packages its products in its own facility. Some of its
other manufacturing processes are conducted by other firms and the Company
expects to continue using outside firms for certain manufacturing processes for
the foreseeable future. The Company's agreements with its suppliers are
terminable at will or by notice. The Company believes that other suppliers
would be available in the event of termination of these arrangements. No
assurance can be given, however, that the Company will not suffer a material
disruption in the supply of its products.
ACCOUNTING STANDARDS
Accounting standards promulgated by the Financial Accounting Standards Board
change periodically. Changes in such standards may have an impact on the
Company's future reported earnings and financial position.
ADDITIONAL RISK FACTORS
Additional factors which might affect the Company's performance may be listed
from time to time in the reports filed by the Company with the Securities and
Exchange Commission.
22
<PAGE> 23
COMMON STOCK PRICE RANGE
The Company's Common Shares were traded on NASDAQ from its initial public
offering on July 20, 1983 through February 10, 1987, under the NASDAQ symbol
3CTHU. From February 10, 1987 to August 3, 1993, the Company's Common Shares
were not part of the automated quotations system. Beginning August 3, 1993, the
company's common shares were traded on the American Stock Exchange Emerging
Company Marketplace and on June 6, 1994, the Company's shares moved to the
primary list of the American Stock Exchange with the symbol CTU. The following
table sets forth, for the periods indicated, the range of high and low closing
bid prices of the Company's Common Shares, as furnished by the National
Quotation Bureau, Incorporated and high and low closing prices as furnished by
the American Stock Exchange. Prices have been adjusted to reflect a 2 for 1
split distributed October 15, 1993, and a 3 for 2 split distributed on October
16, 1995.
QUARTER ENDED HIGH LOW
- --------------------------- ---- ---
June 30, 1995 11-1/8 5-7/16
September 30, 1995 15 9-1/2
December 31, 1995 16 11-3/8
March 31, 1996 15-1/8 11
June 30, 1996 19-1/8 12-1/2
September 30, 1996 19-7/8 15-1/4
December 31, 1996 20-5/8 14-1/8
March 31, 1997 16 10-5/8
Prices prior to August 3, 1993, represent quotations between dealers without
adjustment for retail markups, markdown or commissions and may not represent
actual transactions. As of June 16, 1997, there were approximately XXX
shareholders of record of the Company's common stock. No cash dividends have
been paid on the common stock.
SEC FORM 10-K
A copy of the Company's annual report to the Securities and Exchange Commission
on Form 10-K is available without charge upon written request to:
Senior Vice President
Chad Therapeutics, Inc.
21622 Plummer Street
Chatsworth, CA 91311
23
<PAGE> 1
EXHIBIT 23.1
ACCOUNTANT'S CONSENT
The Board of Directors
Chad Therapeutics, Inc.:
We consent to incorporation by reference in the registration statement
(No. 33-93734) on Form S-8 of Chad Therapeutics, Inc. of our report dated
May 10, 1997, relating to the balance sheets of Chad Therapeutics, Inc. as of
March 31, 1997, and 1996, and the related statements of earnings, shareholders'
equity, and cash flows for each of the years in the three-year period ended
March 31, 1997, which report appears in the March 31, 1997, annual report on
Form 10-K of Chad Therapeutics, Inc.
KPMG Peat Marwick LLP
Los Angeles, California
June 18, 1997
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