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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, 1998
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
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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. [ ]
The aggregate market value of the voting shares held by non-affiliates
of the Registrant on June 12, 1998 (based on the average over-the-counter bid
and asked prices of such stock on such date) was $60,072,000.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of June 12, 1998:
Common Shares 10,012,000
Portions of the Registrant's definitive Proxy Statement for its September
15, 1998, 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, 1998 ("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.
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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 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
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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.
There is also a separate fixed allowance from Medicare for patients who
need to be mobile and therefore require portable oxygen systems.
In January, 1998, the monthly amount that Medicare now reimburses for
home oxygen was reduced by 25% and an additional 5% reduction is scheduled for
January, 1999. While the long term impact of this reduction may be to cause home
care dealers to seek products that provide even greater cost saving
efficiencies, the concerns over the size of these cuts over the past year has,
in many cases, resulted in the provision of systems to patients that do not
provide truly ambulatory oxygen.
While these cost pressures have intensified, 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.
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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 fourteen 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.
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 5%
of the Company's sales in 1998.
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
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systems. The OXYMATIC 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
replaced the previous model. 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 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 38% of the Company's
sales in 1998. 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 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
1998 accounted for approximately 44% of the Company's total sales, of which 52%
represents the sales value of OXYMATIC conservers.
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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 1998 accounted for
approximately 3% of the Company's total sales.
TOTAL 0[subscript]2 Delivery System. In January, 1998, the Company began
marketing the TOTAL 0[subscript]2TM Delivery System. This system provides
stationary oxygen for patients at home, portable oxygen including an oxygen
conserving device for ambulation and a safe and efficient mechanism for filling
portable oxygen cylinders. This should provide home care dealers with a means to
deal with the 25% cut in home oxygen reimbursement that went into effect on
January 1, 1998, by reducing the monthly cost of servicing patients while at the
same time providing them with a higher quality of service. This can be
accomplished as the home care dealer will no longer be required to make regular
monthly service calls to deliver full portable cylinders and the patient will no
longer be dependent on the dealer for those deliveries to obtain full cylinders.
While sales of the TOTAL 0[subscript]2 system have just begun, amounting
to 3% of total sales for 1998, the potential for this product is significant as
the average selling price is approximately four times that of the OXYMATIC and
OXYLITE systems. No assurances can currently be given regarding the level of
success the Company may achieve with the TOTAL 0[subscript]2 system.
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 devices, the OXYMATIC conservers, the OXYCOIL tubing and
the TOTAL 0[subscript]2 system. See "Licensing and Related Agreements".
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 7% of total
sales in 1998.
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
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outside vendor to develop unique oxygen therapy products. The first product
developed from the project was the TOTAL 0[subscript]2 system. No assurance can
be given that any products developed pursuant to this contract will be
successfully marketed or that the Company will ever derive significant revenues
or earnings from the sale of such products.
Research and Development
For the year ended March 31, 1998, the Company expended approximately
$713,000 on research and development and has expended approximately $2,676,000
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 $800,000 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 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
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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.
The Company has also entered into a license agreement (the "Litton
License Agreement") with the Life Support Division of Litton Systems, Inc. for
the TOTAL O(2) Delivery System.
Pursuant to the Litton License Agreement, the Licensor grants to the
Company an exclusive license (with the right to grant sublicenses) to
manufacture, use and sell such device in the health care market. The Litton
License Agreement provides that the Company pay royalties to the Licensor on the
net proceeds of sales of the device covered by the agreement at the rate of 4%.
The Litton License Agreement continues until the expiration of the last to
expire of any patent covering the related device or until the Company ceases
uses of the licensed technology. The Licensors may terminate the Litton License
Agreement at an earlier date if the Company is in arrears for 30 days on any
royalty payment or if the Company defaults in performing any other material
obligation of the agreement and fails to cure such default within 30 days.
Manufacturing and Sources of Supply
The Company tests and packages its products in its own facility. Some
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.
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Production of the OXYMATIC Model 301 and 2400 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.
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.
Production of the TOTAL 0[subscript]2 system is being handled internally
with a number of subassemblies being subcontracted outside the Company. The
Company believes that there are alternate sources of supply for these
subassemblies, including internal manufacturing as production quantities
increase.
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
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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 programs. 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 and
TOTAL O(2) Delivery System 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 has been augmented 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 seven in-house
sales and customer service representatives who are in regular and frequent
proactive telephone sales contact with customers and potential customers. The
Company also utilizes extensive direct mail, trade show attendance, and trade
advertising to promote the benefits of its 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
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largest distributor in Germany covers portions of the 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 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 11% of the Company's
revenues in 1998.
Financial Information Relating to Foreign and
Domestic Operations and Export Sales
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Sales (thousands):
United States $14,866 23,567 17,832
Europe 632 1,146 961
Other 1,095 1,448 1,566
------- ------- -------
Total $16,593 26,161 20,359
======= ======= =======
Gross profit(thousands):
United States $ 7,197 13,509 10,630
Europe 267 572 476
Other 459 724 773
------- ------- -------
Total $ 7,923 14,805 11,879
======= ======= =======
</TABLE>
All identifiable assets are located in the United States.
At March 31, 1998, the Company had a backlog of $510,000 for TOTAL O(2)
systems, including $149,000 related to systems for beta testing. In prior years
the Company has not had any backlog of orders for any of its products. As
production levels for the TOTAL 0[subscript]2 system increase, the Company
presently intends to maintain a
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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.
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 two
companies marketing oxygen conserving devices which claim similar oxygen savings
ratios 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 advantages over the Company's products;
however, the Company believes the established reputation of its products for
efficiency and reliability help 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
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these cylinders is approximately three feet high, weighs over 20 lbs., and
provides an average patient with less than 5 hours of oxygen. These systems are
enjoying some level of success due to their lower unit price advantage. The
OXYMATIC conserver, which provides an average oxygen savings of 7 to 1, allows
the use of smaller, lighter cylinders and thus provides 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. U.S. patents have been issued covering the original
OXYMIZER device, the OXYMIZER Pendant device, the OXYMATIC conserver and the
TOTAL O2 Delivery System. A 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,
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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 "TOTAL 0[subscript]2". 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, OXYMATIC and TOTAL 0[subscript]2
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,
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
16
<PAGE> 17
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, the OXYCOIL and the TOTAL
0[subscript]2 Delivery System; 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, the OXYCOIL and TOTAL 0[subscript]2
Delivery System as Class II devices.
Employees
As of June 12, 1998, CHAD had 87 full-time and no part-time employees.
Fifty-three 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.
17
<PAGE> 18
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 believes 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 becomes 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.
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.
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.
18
<PAGE> 19
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.
19
<PAGE> 20
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, 1998 and 1997
Statements of Operations -- Years ended March 31, 1998, 1997
and 1996.
Statements of Shareholders' Equity -- Years ended March 31,
1998, 1997 and 1996.
Statements of Cash Flows -- Years ended March 31, 1998, 1997
and 1996.
Notes to Financial Statements.
(a) (2) Financial Statement Schedules.
None.
(3) Exhibits.
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*
20
<PAGE> 21
10.20 OXYCOIL tubing License Agreement with Mary Smart (licensed
under the name Respi-Coil).***
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******
10.26 TOTAL O2 Delivery System License Agreement, as amended, with
the Life Support Division of Litton Industries, Inc.
13.1 Annual Report to Shareholders for the year ended March 31,
1998.
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.***
28.7 Letter from the FDA authorizing the Company to market the
TOTAL O2 Delivery System as a Class 2 device
(b) Reports on Form 8-K - None filed.
(c) Index to Exhibits.
(d) Financial Statement Schedules - None
21
<PAGE> 22
- --------------
* 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.
22
<PAGE> 23
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 19th day of June, 1998.
CHAD THERAPEUTICS, INC.
By /s/ Thomas E. Jones
-----------------------------------------
Thomas E. Jones, 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/ Thomas E. Jones Chief Executive Officer June 19, 1998
- ----------------------- and Director (Principal
Thomas E. Jones Executive Officer)
/s/ Francis R. Fleming President, Chief June 19, 1998
- ----------------------- Operating Officer and
Francis R. Fleming Director
/s/ Earl L. Yager Senior Vice President, June 19, 1998
- ----------------------- Chief Financial Officer
Earl L. Yager and Secretary and Director
(Principal Financial and
Accounting Officer)
/s/ Charles R. Adams Chairman of the Board June 19, 1998
- -----------------------
Charles R. Adams
/s/ David L. Cutter Director June 19, 1998
- -----------------------
David L. Cutter
/s/ John C. Boyd Director June 19, 1998
- -----------------------
John C. Boyd
/s/ Norman Cooper Director June 19, 1998
- -----------------------
Norman Cooper
/s/ Philip Wolfstein Director June 19, 1998
- -----------------------
Philip Wolfstein
</TABLE>
23
<PAGE> 24
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Index Sequentially
Exhibit No. Document Numbered Page
- ----------- ------------- -------------
<S> <C> <C>
13.1 Annual Report to Shareholders for the year ended
March 31, 1998
23.1 Consent of Independent Accountant
10.26 TOTAL O2 Delivery System License Agreement, as
amended, with the Litton Life Support division of
Litton Industries, Inc.
28.7 Letter from the FDA authorizing the Company to
market the TOTAL O(2) Delivery System as a
Class 2 device
</TABLE>
24
<PAGE> 1
EXHIBIT 10.26
LICENSE AGREEMENT
This agreement, effective as of the 23rd day of May, 1996 is entered
into by and between the Life Support Division of Litton Systems, Inc., a
Delaware Corporation, having an address at 2734 Hickory Grove Road, Post Office
Box 4508, Davenport, Iowa, 52808-4508 (hereinafter "Licensor") and Chad
Therapeutics, Inc., a California Corporation, having an address at 9445 DeSoto
Avenue, Chatsworth, California 91311 (hereinafter "Licensee").
WHEREAS Licensor has developed oxygen gas concentrator and pressure
intensifier technologies and related products for applications in the military,
industrial and recreational markets and is of the belief that such technologies
have application in the health care market.
WHEREAS Licensee has demonstrated capabilities for manufacturing and
marketing oxygen delivery systems in the health care market.
WHEREAS the parties desire to undertake a program to redesign and
repackage Licensor's technologies referenced hereinabove into a combined oxygen
concentrator and oxygen cylinder charging system which will utilize Licensor's
technologies to provide a product suitable for application in the health care
market.
WHEREAS the parties have entered into a Product Design Agreement
dated April 16, 1996 which, as one of its terms and conditions, requires that
there will be a license agreement permitting Licensee to utilize the Licensor's
technologies for the manufacture and sale of the aforementioned product in the
health care market.
NOW THEREFORE, in consideration of the foregoing premises, the mutual
promises contained herein and other good and valuable consideration, the receipt
of which is hereby acknowledged, and intending to be legally bound hereby
Licensor and Licensee hereby agree as follows:
1
<PAGE> 2
ARTICLE I
Definitions:
As used herein:
A. Territory shall mean the world with the exception of Japan, China,
Taiwan, Korea, Hong Kong, Singapore and Malaysia. One year after the
effective date of this agreement and if the aforementioned expected
countries are available for exclusive licensing of the product, Licensor
shall negotiate in good faith with Licensee for the extension of this
license agreement to include the excepted territories.
B. "Product" shall mean the combination of an oxygen concentrator and
pressure intensifier and cylinder charging system with appropriate
valves, controls and the like and suitable packaging made according to
the specification in paragraph 1 B of the above referenced Product
Design Agreement, which product shall be marketed and sold as a health
care product.
C. "Field of Use" shall mean the health care market excluding the military,
industrial and recreational markets for gas generation delivery or
supply systems.
D. "Licensed Technology" shall mean Licensor's oxygen concentrator and
pressure intensifier technology as embodied in Licensor's proprietary
information, U.S. patent numbers 5,071,543, expiring on December 10,
2008 and 5,354,361, expiring on October 11, 2011 and related foreign
patents, and Licensor's invention disclosure docket number LILS-149 for
which a patent application shall be pending in the United States and
selected foreign countries.
E. "Net Selling Price" shall mean the gross sales or lease price by which
Licensee transfers title or possession of a Product less only usual
trade discounts, sales tax which the seller has to pay or absorb, custom
duties and transportation and insurance charges, if not included in the
gross price, and any and a federal, foreign, state or local taxes
(except income tax) incurred by the seller on such sales or leases.
2
<PAGE> 3
F. "Sales, Sell or Sold", shall mean any sale, transfer, lease, license,
permission to use or other transfer of the right of possession or title
or other conveyance by Licensee.
G. "Proprietary Information" shall mean any scientific or technical
information, design, process, procedure, formula or improvement that is
competitively advantageous and secret and that is not generally known in
the industry and any data or information having competitive advantages
which may include, but not be limited to, data, data bases, software,
product plans, strategies, materials, customer names and other
information related to customers, price fists, pricing policies and
financial information which the parties consider sensitive and which is
not generally known to the public. The term Proprietary Information
specifically includes those items which might otherwise be known as
knowhow or trade secrets. It shall not include information which is not
marked as "Proprietary Information" or an equivalent term.
ARTICLE II
License Grant:
A. Licensor hereby grants to Licensee an exclusive, nontransferable,
royalty bearing license with a right of sublicense to make, use and sell
Products throughout the Territory in the Field of Use.
B. Any provision of this agreement to the contrary notwithstanding,
Licensor reserves the right to make, use and sell Products according to
the Licensed Technology in others than the Field of Use anywhere and in
the Field of Use outside the Territory and to use the Licensed
Technology in the military, industrial and recreational markets for any
purpose.
ARTICLE III
Consideration and Payments:
3
<PAGE> 4
A. In consideration of the granting herein of the license as described in
Article II, Licensee shall pay Licensor:
1. A nonrefundable licensing fee in the amount of $1,250,000.00 to
be paid in the following installments:
a. On the effective date of this agreement a payment of
$150,000.00.
b. On each of the dates July 15, 1996 and November 15, 1996
payments in the amount of $250,000.00, respectively.
C. On each of the dates February 15, 1997 and April 15,
1997 payments of $300,000.00, respectively.
2. Royalties at the rate of 4% of the Net Selling Price of Products
sold or leased by Licensee or any sublicensee under this
agreement. In the event that by reason of the action of a court
or tribunal of competent jurisdiction no valid claim of any
existing U. S. patent or U.S. patent which matures from a patent
application owned by Licensor covers the Product, Licensee or
any sublicensee shall have the right to reduce the aforesaid
royalty rate to 2% of the Net Selling Price. Additionally,
Licensee or any sublicensee shall deposit the amount of the
difference between 4% and 2% royalties into escrow until such
time that the validity or enforceability of any such claim
covering a Product is determined from which there can be no
further appeal or review. If all claims covering a Product are
determined invalid or unenforceable and there can be no further
appeal or review of such decision, Licensee or a sublicensee
shall have the right to dispose of the escrowed royalties in any
manner they deem necessary and reasonable, otherwise the
escrowed amounts shall be paid to Licensor.
B. All payments to Licensor under this agreement shall be made in U.S.
dollars at Licensor's address for notice. The payments listed in
paragraph A1 shall be made on the stated dates.
4
<PAGE> 5
The royalty payments shall be paid to Licensor quarterly on a calendar
year basis. Payments for sales made during each quarter of each calendar
year shall be made to Licensor within thirty (30) days after the last
day of each calendar quarter.
C. Licensee shall pay all royalties due hereunder to Licensor and Licensor
shall not be required to look to any other entity for payment.
ARTICLE IV
Sublicenses:
A. Subject to this paragraph, Licensee may grant sublicenses to persons or
entities specifically approved in writing by Licensor, which approval
shall not be unreasonably withheld, provided that each sublicense
contains a provision that such sublicense and the rights thereby granted
are personal to the sublicensee thereunder and such sublicense cannot be
further assigned or sublicensed.
B. Any sublicense granted pursuant to this Article shall be in accordance
with the terms and conditions of this agreement.
C. In respect of any sublicense granted by Licensee in accordance with this
article, Licensee shall promptly pay to Licensor an amount equal to 25%
of any lump sum or other payment, howsoever calculated, in addition to
the royalties set forth in Article III above, made by the sublicensee
thereunder in consideration for the grant of such sublicense to it by
the Licensee.
ARTICLE V
Accounts:
A. Not later than March 1 of each calendar year, Licensee shall furnish to
Licensor a statement showing the total net sales of products made
according to the Licensed Technology by
5
<PAGE> 6
Licensee during the immediate preceding calendar year and the royalties
payable thereon calculated in the manner required in Article III.
B. Licensee shall keep at its usual place of business true and accurate
accounts of all matters connected with the use of the Licensed
Technology and the manufacture and sale of all Products and shall keep
books of account relating to royalties payable hereunder containing true
entries complete in every particular as may be necessary or proper for
enabling the amount of such royalties to be conveniently ascertained.
C. If requested in writing by Licensor, Licensee shall at all reasonable
times produce evidence of the matters referred to in this Article V and
shall permit such evidence to be verified by an independent accountant
to be selected and paid for by Licensor. Licensee shall give such
accountant all necessary facilities for verifying such evidence and
shall give such information as may be necessary or proper to enable the
amount of the royalties to be verified.
ARTICLE VI
Improvement:
A. Should Licensee, or any consultant or employee of Licensee, during the
term of this agreement make or discover any improvement in the Licensed
Technology, whether patentable or not, Licensee shall forthwith disclose
or cause the same to be disclosed to Licensor. Licensee shall own all
right, title and interest in any such discovery or improvement. However,
Licensee shall make available to Licensor any improvements or
modifications it makes to the Licensed Technology and grant Licensor an
irrevocable, nonexclusive, royalty free unrestricted license to use the
improvements for the purposes stated in Article II, paragraph B. If so
requested by Licensor, Licensee shall make available or supply to
Licensor such information or data as is necessary or convenient for the
proper understanding or use of such discovery or improvement.
6
<PAGE> 7
B. If Licensor makes or discovers any improvement in the Licensed
Technology, whether patentable or not, which if practiced would
constitute an infringement of any patent included in the Licensed
Technology or would be obvious to one skilled in the art in view of any
description of the Licensed Technology, Licensor shall forthwith
disclose or cause the same to be disclosed to Licensee and such
improvement shall be deemed to be included in the term "Licensed
Technology" and to be included in this agreement and be subject to the
terms hereof
ARTICLE VII
Confidentiality:
A. Licensee shall not disclose any Proprietary Information other than to
Licensee employees who must have access to such information in order to
carry out Licensee's obligations under this agreement, and to potential
sublicensees of the Licensed Technology, providing such disclosure is in
accordance with paragraph C of this Article. Prior to disclosure of
Proprietary Information to Licensee employees, such employees shall be
under a written obligation of confidentiality to Licensee consistent
with this agreement. Trade secrets and knowhow shall be maintained in
confidence by Licensee for so long as such information is maintained in
confidence by Licensor.
B. To protect Licensor's Proprietary Information, Licensee shall adopt
security measures commonly observed in industries that rely on
Proprietary Information. These measures shall include, but not be
limited to, restricted access to such information, marking such
information and the selective destruction of sensitive materials. Upon
termination of this agreement, Licensee shall return or destroy all
documents or materials embodying Licensor's proprietary information.
C. Any disclosure of Proprietary Information by Licensee to potential
vendors, subcontractors or sublicensees of the Licensed Technology shall
be prohibited, unless such potential vendor
7
<PAGE> 8
subcontractor or sublicensee has signed an agreement which imposes
obligations of confidentiality and nonuse at least as restrictive as
those imposed on Licensee hereunder.
ARTICLE VII
Initial Development and Full Use of Licensed Technology:
Should Licensor not receive a minimum of $100,000.00 in royalties from
Licensee during the third year of this agreement as measured from the effective
date of hereof, $300,000.00 during the fourth year and $500,000.00 during the
fifth year and each year thereafter, Licensor shall have the option to terminate
the license granted hereunder, to allow this agreement to continue in full force
and effect or to convert the exclusive license granted hereunder to a
nonexclusive license. The exercise of this option shall be taken only on sixty
(60) days written notice to Licensee. During the latter sixty (60) day period,
Licensee may prevent such option from being exercised by paying Licensor an
amount equal to the difference between the minimum royalty required for the year
for which notice is given and the amount of royalty actually paid.
ARTICLE IX
Protection of Intellectual Property:
A. The cost of preparing, prosecuting and maintaining the patent
application included in the Licensed Technology and any other patent
applications or copyright applications the Licensor determines to file
on improvements as defined in Article VI shall be borne by Licensor.
B. Licensee shall cooperate with Licensor in enforcing or policing
intellectual property protection for the Licensed Technology and
improvements as provided in Article X hereinbelow and by taking all
appropriate measures including marking Proprietary Information as
required.
8
<PAGE> 9
ARTICLE X
Notice of Infringement and Enforcement of Rights:
A. Immediately upon Licensee's learning of any infringement,
misappropriation or unauthorized use of Licensor's Proprietary
Information, patents or other intellectual property rights pertaining to
the Licensed Technology, Licensee shall promptly inform Licensor.
B. If Licensee and Licensor agree to jointly pursue enforcement of
Licensor's intellectual property rights, then the parties hereto shall
share equally all costs, fees and/or expenses incurred in connection
with enforcement of Licensor's intellectual property rights provided
only that Licensor's maximum exposure for such costs, fees and expenses
shall be the amounts of compensation paid and/or payable to Licensor by
Licensee hereunder. Any payments accruing from such action to enforce
Licensor's intellectual property rights shall be paid to Licensee and
Licensor in proportion to the party's respective contributions to all
costs, fees and/or expenses incurred in such action.
C. In the event that either party shall determine for any reason that it
does not choose to enforce Licensor's intellectual property rights then
that party shall promptly notify the other party of such decision. The
party choosing to enforce Licensor's intellectual property rights may
then proceed with such enforcement action solely at its own expense and
any and all recoveries shall be awarded solely and exclusively to that
party. However, it is agreed that said other party shall cooperate in
enforcement of the intellectual property rights, such as by providing
witnesses and other evidence as needed by the enforcing party at the
cost of the enforcing party.
ARTICLE XI
Indemnity:
A. License hereby indemnifies holds harmless Licensor, its parent
corporation, affiliates and
9
<PAGE> 10
their employees, officers, board members and agents from and against all
claims, suits, liabilities, damages, costs, fees, expenses or losses
arising out of or resulting from Licensee's performance of this
agreement, including any damages, losses or liabilities whatsoever with
respect to death or injury to any person and damage to any property
arising from the possession, use or operation of Products produced or
sold by Licensee or its sublicensees or their customers in any manner
whatsoever. This indemnity shall not apply to claims, suits,
liabilities, damages, costs, fees, expenses or losses directly
attributable to components or subassemblies supplied by Licensor, for
use in Products of Licensee.
B. Licensor hereby indemnifies and holds harmless Licensee and its
employees, officers, board members and agents from and against all
claims, suits, liabilities, damages, costs, fees, expenses or losses
arising out of third party claims against Licensee (1) for patent,
copyright and/or trademark infringement resulting directly from
Licensee's use of the Licensed Technology in the manufacture and sale of
the Products and (2) for product liability directly relating to the
licensed technology. This indemnity does not extend to claims of
infringement arising from combinations of the Licensed Technology with
Licensee's technology or Licensee's modifications to the Licensed
Technology.
ARTICLE XII
Disclaimer, Warranty and Limitation of Liability:
Except as expressly set forth in this agreement, Licensor disclaims any
and all promises, representations and warranties with respect to the Licensed
Technology, including its condition, conformity to any representation or
description, the existence of any latent or patent defects therein and its
merchantability or fitness for a particular use or purpose.
ARTICLE XIII
Ownership of Licensed Technology.
Licensor represents that it is the exclusive owner by assignment from
the inventors and its
10
<PAGE> 11
employees of the Licensed Technology, that it has the right to grant the License
herein granted, and that prior to the effective date of this agreement, it has
not granted, nor is it under any obligation to grant, any person or party any
right, license, shopright or privilege under the Licensed Technology
ARTICLE XIV
Trademarks:
Except for purposes of descriptively identifying the Licensed
Technology, no right, title, interest or license to any trademark or service
mark of Licensor is granted to Licensee.
ARTICLE XV
Relationship Between the Parties:
Licensor and Licensee are and shall remain independent contractors and
nothing herein shall create a partnership or joint venture between Licensor and
Licensee.
ARTICLE XVI
Advertising, Publicity and Publications:
A. Except as otherwise provided herein, Licensee shall not use the names of
Litton Systems, Inc. or Litton Industries, Inc. or any of their
respective affiliates or divisions in any advertisement or sales
materials without the prior written consent of Licensor.
B. In any publication (including advertisements, sales and trade literature
and instruction manuals) relating to the Licensed Technology used
pursuant to this agreement, Licensee shall give due credit to Licensor
as owner and Licensor of the Licensed Technology.
ARTICLE XVII
Term and Termination:
A. This agreement shall commence on the stated effective date of this
agreement and shall
11
<PAGE> 12
continue until the expiration of the last expiring patent covering any
of the Licensed Technology licensed hereunder or the cessation of use of
the Proprietary Information by Licensee, whichever is later.
Notwithstanding the foregoing the obligations of the parties under
Article VII, XI and XII shall survive any termination of this agreement.
B. In the event of the breach of a material obligation hereunder by either
party, the nonbreaching party shall inform the alleged breaching party
of said breach in writing. The alleged breaching party shall have thirty
(30) days from the date of said notification during which time to cure
the breach. In the event the alleged breaching party does not cure the
breach within thirty (30) days, the nonbreaching party may terminate
this agreement.
C. In the event the aforementioned Product Design Agreement is terminated
for any of the reasons fisted in Article VIII of that agreement, either
party shall have the option to terminate this agreement. However, any of
the sums due Licensor under Article III upon the date of termination
shall be paid to Licensor within thirty (30) days after such
termination.
D. Licensee shall within thirty (30) days of termination of this agreement
for any reason deliver to Licensor all written documentation in the
possession of Licensee which contains Proprietary Information pertaining
to the Licensed Technology.
ARTICLE XVIII
Tooling and Supplies:
A. Licensor shall manufacture and sell any pressure intensifiers (boost
pumps) required for the Products to Licensee on an exclusive basis for
the Field of Use within the Territory.
B. Licensor shall sell to Licensee on a nonexclusive basis and Licensee
shall buy from Licensor its requirements for oxygen monitors for the
Products.
C. Licensor shall retain ownership of the tooling for the aforementioned
pressure intensifiers. However, Licensee will purchase and retain
ownership of any remaining tooling required for the manufacture of the
Product.
12
<PAGE> 13
D. In the event that Licensor is unable or unwilling to supply Licensee's
requirements for pressure intensifiers (boost pumps) and oxygen
monitors. Licensor shall sell to Licensee the aforesaid tooling and
technical information (specifications, material lists, vendor lists,
assembly instructions and the like) necessary to manufacture the
pressure intensifiers or oxygen monitors at Licensors then fair market
value, not to exceed $250,000.00, for said tooling and technical
information. Said tooling and technical information shall only be
utilized by licensee to manufacture the products.
ARTICLE XIX
Notices:
All notices required or permitted under this agreement shall be in
writing and shall be delivered personally or sent by certified registered mail
to Licensee or Licensor at the addresses set forth below.
To Licensor: To Licensee:
P.O. Box 4508 9445 De Soto Avenue
2734 Hickory Grove Road Chatsworth, California 91311
Davenport, Iowa 52808-4508
ARTICLE XX
Waiver:
Waiver by either party of any term or provision of this agreement shall
not constitute a continuing waiver thereof nor of any further or additional
rights such party may hold under this agreement.
13
<PAGE> 14
ARTICLE XXI
Severability:
If any provision of the agreement shall be held to be invalid, illegal
or unenforceable, the validity, legality or unenforceability of the remaining
provisions shall not in any way be affected or impaired.
ARTICLE XXII
Governing Law and Disputes:
A. This agreement shall be construed in accordance with the laws of the
State of Iowa, with the exception of its rules on the conflicts of laws.
B. Any disputes arising under this and/or the Product Design Agreement
shall be decided by arbitration in accordance with the rules of the
American Arbitration Association. Each party shall appoint an
arbitrator, and the two, thus selected, shall appoint a third. If either
party fails to appoint an arbitrator within sixty (60) days after
receipt of the notice from the other party of its appointment of an
arbitrator, or if the arbitrators fail to appoint a third, the
appointment(s) shall be made by the President of the American
Arbitration Association or his designee. The arbitration will be held as
promptly as possible at a time and place determined by the arbitrators.
The decision of a majority of the arbitrators shall be final and binding
upon the parties hereto, and the expense of the arbitration shall be
shared equally by the parties. Judgement upon the award can be entered
in any court having jurisdiction, or application can be made to such
court for a judicial acceptance of the award and an order of
enforcement, as the case may be.
14
<PAGE> 15
ARTICLE XXIII
Miscellaneous:
A. This agreement along with the Product Design Agreement are the complete
and exclusive statements between the parties relating to the subject
matter hereof, and supersedes all prior understandings, communications
or representations, either oral or written between the parties. This
license agreement may not be modified or altered except by a written
instrument duly executed by the parties hereto.
B. Subject to this paragraph, the license is personal to Licensee. It is
expressly understood that this agreement may not be assigned by either
party without the prior written consent of the other.
C. This agreement shall bind and entire to the benefit of the parties
hereto and their respective successors and permitted assigns, but
nothing contained herein shall be deemed to permit assignment by either
party except as otherwise permitted in this agreement.
D. Neither party shall be held in breach of this agreement because of acts
or omissions caused by any act of God or other cause beyond the control
of the parties including but not limited to fire, floods, labor disputes
or other unforeseen circumstances.
IN WITNESS WHEREOF the parties have set their hands and seals and duly
executed this agreement effective as of the date first written above.
Litton Systems, Inc. Chad Therapeutics, Inc.
Life Support Division
By /s/ JOHN J. HEFFERNAN By /s/ CHARLES R. ADAMS
------------------------ ------------------------
Title Pres. Title CEO
--------------------- ---------------------
Date 5-31-96 Date 5-31-96
---------------------- ----------------------
15
<PAGE> 16
FIRST AMENDMENT TO LICENSE AGREEMENT
This First Amendment to the License Agreement (the "License First
Amendment") is entered into and made effective as of the 3 day of September,
1996 by and between the Life Support Division of Litton Systems, Inc., a
Delaware corporation, having its address at 2734 Hickory Grove Road, PO Box
4508, Davenport, Iowa 52808 (hereinafter referred to as "Licensor") and Chad
Therapeutic, Inc., a California corporation having its address at 9445 DeSoto
Avenue, Chatsworth, California 91311 (hereinafter referred to as "Licensee"),
and hereinafter collectively referred to as "Parties" and individually as
"Party".
RECITALS
WHEREAS, Litton and Chad entered into a License Agreement having an
effective date of April 16, 1996 (hereinafter the "License Agreement") for the
design by Litton of a Home Oxygen Concentrator and Cylinder Charging System
(referred to in the License Agreement as "Product" or "Device"); and
WHEREAS, the Parties desire to amend the terms of the License Agreement
as set forth herein;
NOW, THEREFORE, in consideration of the foregoing premises, the mutual
promises contained herein and other good and valuable consideration, the receipt
of which is hereby acknowledged, and intending to be legally bound hereby,
Licensor and Licensee hereby agree to amend the License Agreement as follows:
1. The term "Licensed Technology" shall be amended by the addition of
the following to the end of the definition: "Licensed Technology shall also
include all technical information, computer software, trade secrets and related
intellectual property, including, without limitation, patented technology,
covering the Oxygen Monitor and Test Equipment and related manufacturing
technology to be developed by Licensor and disclosed to Licensee under the terms
of the First Amendment to the Product Design Agreement.
2. All other terms and conditions of the License Agreement shall remain
in full force and effect and shall cover the reciprocal obligations of the
parties to the extent that they have been modified by this First Amendment.
1
<PAGE> 17
IN WITNESS WHEREOF, the Parties have set their hands and seals and duly
executed this License First Amendment effective as of the date first written
above.
Litton Systems, Inc.
Life Support Division
By:/s/ JOHN J. HEFFERNAN
-----------------------------
John J. Heffernan
Title: President - Litton Life Support Division
Chad Therapeutic Inc.
By:/s/ CHARLES R. ADAMS
-----------------------------
Charles R. Adams
Title: Chairman, CEO
2
<PAGE> 18
SECOND AMENDMENT TO LICENSE AGREEMENT
This Second Amendment to the License Agreement (the "License Second
Amendment") is entered into and made effective as of the 7 day of November 1996
by and between the Life Support Division of Litton Systems, Inc., a Delaware
corporation, having its address at 2734 Hickory Grove Road, PO Box 4508,
Davenport, Iowa 52808 (hereinafter referred to as "Licensor") and Chad
Therapeutic, Inc., a California corporation having its address at 9445 DeSoto
Avenue, Chatsworth, California 91311 (hereinafter referred to as "Licensee"),
and hereinafter collectively referred to as "Parties" and individually as
"Party".
RECITALS
WHEREAS, Litton and Chad entered into a License Agreement having an
effective date of April 16, 1996 (hereinafter the "License Agreement") for the
design by Litton of a Home Oxygen Concentrator and Cylinder Charging System
(referred to in the License Agreement as "Product" or "Device"); and
WHEREAS, the parties entered into a First Amendment to the License
Agreement; and
WHEREAS, THE Parties desire to further amend the terms of the License
Agreement as set forth herein;
NOW, THEREFORE, in consideration of the foregoing premises, the mutual
promises contained herein and other good and valuable consideration, the receipt
of which is hereby acknowledged, and intending to be legally bound hereby,
Licensor and Licensee hereby agree to amend the License Agreement as follows:
1. The term "Licensed Technology" shall be amended by the addition of
the following to the end of the definition: "Licensed Technology shall also
include all technical information, computer software, trade secrets and related
intellectual property, including, without limitation, patented technology,
covering the High Pressure Fill Port and Pressure Vessel Flow Controller and
related manufacturing technology to be developed by Licensor and disclosed to
Licensee under the terms of this Second Amendment to the Product Design
Agreement.
1
<PAGE> 19
2. All other terms and conditions of the License Agreement shall remain
in full force and effect and shall cover the reciprocal obligations of the
parties to the extent that they have been modified by the Second Amendment.
3. In addition to the Licensed Technology statements, the "Product"
definition in Article 1, section B of the License Agreement shall be modified to
reflect the project changes which have transpired since the FDA meeting in July,
1996. The product name, Chad Total Oxygen Delivery System, indicates that the
Product has evolved from an oxygen concentrator to an oxygen delivery system.
The "Product" definition shall be modified to include all of the components
packaged by Chad which make up the "System" that are the results of the Litton
design effort described under the Product Design Agreement and its amendments.
As of the effective date of the License Second Amendment, these components
include the CTODS oxygen concentrator and all portable oxygen cylinders equipped
with the pressure vessel flow control valve (Special Fitting). The terms of the
License Agreement shall govern all portable oxygen cylinders equipped with the
pressure vessel flow control valve (Special Fitting) regardless of whether they
are sold with the "System" or sold separately.
IN WITNESS WHEREOF, the Parties have set their hands and seals and duly
executed this License Second Amendment effective as of the date first written
above.
Litton Systems, Inc.
Life Support Division
By: /s/ JOHN J. HEFFERNAN
-------------------------------
John J. Heffernan
Title: President - Litton Life Support Division
Chad Therapeutic Inc,
By: /s/ CHARLES R. ADAMS
-------------------------------
Charles R. Adams
Title: Chairman, CEO
2
<PAGE> 20
THIRD AMENDMENT TO LICENSE AGREEMENT
This Third Amendment to the License Agreement (the "License Third
Amendment") is entered into and made effective as of the 15 day of October, 1997
by and between the Life Support Division of Litton Systems, Inc., a Delaware
corporation, having its address at 2734 Hickory Grove Road, P.O. Box 4508,
Davenport, Iowa 52808 (hereinafter referred to as "Licensor") and Chad
Therapeutic, Inc., a California corporation having its address at 21622 Plummer
Street, Chatsworth, California 91311 (hereinafter referred to as "Licensee"),
and hereinafter collectively referred to as "Parties" and individually as
"Party".
RECITALS
WHEREAS, Litton and Chad entered into a License Agreement having an
effective date of April 16, 1996 (hereinafter the "License Agreement") for the
design by Litton of a Home Oxygen Concentrator and Cylinder Charging System
(referred to in the License Agreement as "Product" or "Device"); and
WHEREAS, the parties entered into a First Amendment to the License
Agreement having an effective date of September 3,1996 and a Second Amendment to
the License Agreement having an effective date of October 29, 1996; and
WHEREAS, the parties desire to further amend the terms of the License
Agreement as set forth herein;
NOW, THEREFORE, in consideration of the foregoing premises, the mutual
promises contained herein and other good and valuable consideration, the receipt
of which is hereby acknowledged, and intending to be legally bound hereby,
Licensor and Licensee hereby agree to amend the License Agreement and the
amendments thereto referenced above as follows:
1. Licensor hereby grants to Licensee an option to obtain an exclusive,
non-transferable, royalty-bearing license with a right of sublicense to make,
use and sell Products in the Field of Use in Japan, China, Taiwan, Korea, Hong
Kong, Singapore and Malaysia (hereinafter the "Option").
<PAGE> 21
2. The Option shall be exercisable by Licensee from the effective date
of this License Third Amendment through December 31, 1999, after which time the
Option shall expire.
3. If Licensor exercises the Option, then Licensee shall pay Licensor
the following sums:
(a) Licensee shall pay Licensor the sum of $100,000 within ten
business days after Licensee notifies Licensor of its exercise
of the Option; and
(b) Licensee shall pay Licensor a second sum of $100,000 twelve
months after the date on which Licensee has notified Licensor of
its exercise of the Option.
4. As further consideration for the grant of said Option, Licensee shall
pay to Licensor royalties at the rate of four percent (4%) of the Net Selling
Price of Products sold or leased by Licensee or any sublicensee in China,
Taiwan, Korea, Hong Kong, Singapore or Malaysia. For sales of Products in Japan,
Licensee shall pay to Licensor a royalty at the rate of six percent (6%) of the
Net Selling Price of Products sold in Japan by Licensee or a sublicensee.
5. In consideration of Licensor deferring its right to make use of the
Licensed Technology in Japan, China, Taiwan, Korea, Hong Kong, Singapore or
Malaysia during the time that the Option is available for exercise by Licensee,
Licensee shall pay to Licensor the sum of $50,000 on or before January 31, 2000
if Licensee does not exercise the Option within the time period set forth in
Paragraph 2 herein.
IN WITNESS WHEREOF, the Parties have set their hands and seals and duly
executed this License Third Amendment effective as of the date first written
above.
LITTON SYSTEMS, INC. CHAD THERAPEUTIC, INC.
LIFE SUPPORT DIVISION
By: /s/ JOHN J. HEFFERNAN By: /s/ CHARLES R. ADAMS
------------------------------- -------------------------------
John J. Heffernan, President Charles R. Adams
Litton Life Support Division Chairman, CEO
<PAGE> 1
EXHIBIT 13.1
[PHOTOGRAPH OF CHAIRMAN]
Charles R. Adams
Chairman of the Board
LETTER FROM THE CHAIRMAN
For the past seven years or more it has been a personal pleasure to write this
opening paragraph. I was able to report phenomenal success and growth in both
sales and earnings and the establishment of many new records each year. That is
not the case for fiscal 1998 as both sales and earnings declined significantly.
While it was a disappointing year in terms of our financial performance, we
remain in solid financial condition and progress is being made towards regaining
our growth pattern. I will let Tom Jones, your new Chief Executive Officer,
review plans and the outlook for the future in his letter to you which follows
and I will attempt to review the events and causes of the difficult year just
concluded.
During much of calendar year 1997 discussions and negotiations were being held
as the federal government tried to achieve a balanced budget. As these
negotiations took place rumors became rampant regarding the size of the proposed
reduction in reimbursement for home oxygen services by Medicare, with some
estimates as high as 40%. This had a significant impact on home oxygen providers
all over the country in two major ways. Providers reduced spending as much as
possible as they scrambled to minimize costs and expenses; and they became
seriously concerned about their ability to survive in business with these
proposed drastic reductions. The final budget bill enacted in the fall included
a 25% cut in home oxygen reimbursement, which went into effect on January 1,
1998, with an additional 5% cut to become effective January 1, 1999. As a result
providers continued their efforts to reduce expenses. In Chad's area of portable
oxygen, many took drastic measures and reverted to the methods of ten or more
years ago, substituting the old large bulky cylinders and carts for more modern
and truly ambulatory systems.
Another impact of the turmoil over reimbursement cuts was the increase in
consolidation activity that resulted in strong independent dealers being
acquired by large national chains. Independents have been, by far, the largest
and most important part of Chad's business. Chad's independent dealers have also
been the most attractive acquisitions for the national chains because of
<PAGE> 2
their growth and profitability, due in large part to Chad's efficient and
desirable systems. The loss of these dependable customers as they complied with
the purchasing policies of their new owners was a substantial loss to Chad.
The Company also faced a form of competition that had heretofore not manifested
itself. There had been competition in the oxygen conserving device market for
several years but it had never been serious. There was no other electronic
conserver that could compete with Chad's OXYMATIC conserver because of its
clearly superior oxygen savings efficiency. We had always argued that the only
logical reason for using an oxygen conserving device was to conserve as much
oxygen as possible. Chad's OXYMATIC conserver provided an average savings ratio
of seven to one compared with competitive devices three to one savings at best.
However, the first half of fiscal 1998 brought several new conserving devices to
the market with all of them competing on the basis of unit cost of the device.
They accomplished something I never would have believed possible. They
successfully got a number of physicians, therapists and providers to think of
oxygen conservers as generic products without regard to efficiency.
Consequently, the market became more unit price sensitive and cheaper electronic
conservers captured some of the loyal market we had built over the years. The
good news is that despite the loss in market share in the past year the OXYMATIC
conserver is still the market leader and recent indications are that unit sales
of this product are on the rise again as providers are learning to cope with the
reimbursement cuts.
During this time the Company was working to complete development of the new
TOTAL 0[subscript]2(TM) Delivery System. It promises to be the right product at
the right time for both the Company and the home oxygen industry. The TOTAL
0[subscript]2 system provides stationary oxygen for the patient at home,
portable oxygen including an oxygen conserving device for ambulation and a safe
efficient mechanism to fill the portable unit from the stationary unit. It can
improve providers' profitability by reducing the cost of servicing patients
while at the same time delivering a higher quality of service to those patients
as they are no longer restricted in the amount of ambulatory oxygen they can
use. Truly the right product at the right TIME. The Company previewed the new
product in early October at the Medtrade show in New Orleans to great
enthusiasm. However, it was not ready to sell as clearance was not received from
the FDA until mid-November and shipping did not begin until January as the
Company and its suppliers refined manufacturing practices for the new system.
Manufacturing processes are still being refined as the Company works to increase
production capability of the TOTAL 0[subscript]2 system. We did ship $535,000 in
TOTAL 0[subscript]2 systems through March 31, 1998, and had a $361,000 backlog
of systems at that date. Tom Jones will review expectations for the new product
in his report, including the product's international potential.
I certainly would have much preferred a different outcome for this, my last year
as Chad's CEO. Even so, I still feel very good and increasingly optimistic about
the Company's future with the opportunities we have and Tom Jones to lead us. I
wouldn't trade my experiences of the past 16 years and my wonderful associations
for anything. That includes not only Chad management and employees but the many
loyal friends who have invested in Chad.
Although I'm no longer a part of management, as Chairman of the Board I would
like to promise you once again that we will all do our very best.
Charles R. Adams
/s/ CHARLES R. ADAMS
Chairman of the Board of Directors
5
<PAGE> 3
[PHOTOGRAPH OF CEO]
Thomas E. Jones
Chief Executive Officer
I am pleased to be able to write to you as your new Chief Executive Officer.
While the respiratory care industry faces many challenges today I am excited
about the opportunities the Company currently has before it and look forward to
working with the people at Chad to achieve the Company's potential.
After the shock of experiencing the reality of a 25% across the board Medicare
oxygen revenue reduction (effective January 1, 1998), our home care provider
customers, we believe, are rolling up their sleeves and going about the tasks of
re-engineering their businesses to absorb this revenue reduction as well as the
5% reduction scheduled for January 1, 1999. For the most part, they also
recognize that these revenue cuts will not be the end of the cost reduction
pressure in the health care arena. The Competitive Bidding study mandated by
Congress is only one example of further pricing pressure.
With this atmosphere in mind, I cannot envision a more appropriate time to be
offering a product such as the Total 0[subscript]2"(TM) Delivery System. Not
only is the reimbursement structure forcing home care providers to learn how to
deliver oxygen to home care patients more efficiently, but the growth of the
home oxygen patient base, driven by chronic obstructive pulmonary disease
(COPD), continues at about 8-10% annually by most estimates.
From our perspective the clinical advantages of ambulatory oxygen for the
increasingly mobile patient population continues to align the market
characteristics in favor of innovative lower total cost home oxygen patient
solutions, such as the Total 0[subscript]2 system.
The adoption of the Total 0[subscript]2 system lends itself to those home care
providers who want to and are willing to technologically leapfrog their
competition to achieve lower costs and a higher quality of service for
ambulatory patients. Some home care providers who wish to try to incrementally
squeeze their costs to regain acceptable profitability in the face of Medicare
revenue cuts are very reluctant to adopt a new technology such as the Total
0[subscript]2 system, which requires changes in various operating
<PAGE> 4
approaches such as rationalizing or eliminating truck delivery schedules.
However, for those providers willing to "think outside the box" and restructure
their businesses, we believe the rewards will be great. For several of our
"early adopters" of the Total 0[subscript]2 system, the rewards appear to be
very significant in achieving lower operating costs, increasing market share and
improving patient satisfaction. Several of these "early adopter" accounts are
having excellent success directing media ads at patients through Chad's co-op
advertising program to gain market share.
The U.S. market for home oxygen systems is generally estimated to be in the area
of $250-$300 million with unit volume of oxygen systems at 250-300 thousand for
calendar 1997. With the non-U.S. market adding approximately 25% to those U.S.
numbers, the size of the opportunity for Chad is enormous even when one accounts
for the non-ambulatory patients who have been built into these base estimates.
With so large a market opportunity before us we are currently exploring various
methods of achieving more effective sales efforts including utilizing some form
of field sales organization to provide face-to-face sales representatives to
sell the Total 0[subscript]2 system to home care providers. We would expect to
come to some conclusion and have a plan implemented by the time you receive this
Annual Report.
After the sharp erosion of our market share in the traditional OXYMATIC
conserver product line during fiscal 1998, we believe this profitable line is
beginning to grow again. We believe this is due to both regaining some
historical customers as well as the expanding market discussed earlier combined
with home care providers search for the most cost efficient products to deal
with the recent Medicare reimbursement cuts.
In the International arena, we can tell you that interest in the Total
0[subscript]2 system is high. Converting this interest to sales revenues will
however take time and much effort due to both the necessary regulatory approvals
as well as the various reimbursement structures outside the U.S. which, in some
cases, do not necessarily favor cost reductions for home oxygen delivery. Cost
reduction pressures are however, consistent in virtually every venue, so most
foreign health care systems are examining ways to reduce healthcare costs over
time. We are nevertheless pursuing regulatory approval in numerous foreign
venues. In some countries we, along with our selected distributors, may need to
pursue modifications of drug delivery regulations to allow delivery of 93%
oxygen via compressed gas cylinders. We do however anticipate modest but growing
revenue during fiscal 1999 for the Total 0[subscript]2 system.
With regard to the traditional OXYMATIC conserver and related products, we
anticipate some recovery from fiscal 1998. However, significant growth and
penetration in international markets is not expected until the regulatory
approvals are received for the Total 0[subscript]2 system.
For this coming year, Chad's focus will be on the following objectives:
- To achieve smooth and efficient Total 0[subscript]2 system
manufacturing operations with the ability and plan to expand
manufacturing volume as necessary
- To achieve sales and market penetration in the U.S. consistent
with the large opportunities that the current market conditions
offer
- To continue preparation for introduction of the Total
0[subscript]2 system to international markets, and
- To pursue and develop the new product opportunities which we
have before us
These objectives will certainly challenge everyone within the Chad team.
However, I have no doubt that these things can be accomplished with the
outstanding group of fellow employees here at Chad.
Thomas E. Jones
/s/ THOMAS E. JONES
Chief Executive Officer
7
<PAGE> 5
ISO 9000 CERTIFICATION
CHAD RECEIVES ISO 9000 CERTIFICATION AND CE MARK
By: Louie Goryoka, Vice President Quality Assurance and Regulatory Affairs
[PHOTOGRAPH OF VICE PRESIDENT QUALITY ASSURANCE]
Louie Goryoka
Vice President Quality Assurance
and Regulatory Affairs
One of the most significant changes in domestic and international business is
the recent movement toward quality awareness. The importance of quality and
reliability is becoming recognized as a critical factor for the sale of many
products and services. This growth in international quality awareness has
resulted in customer and consumer demand for products and services that are
entirely suitable for the purpose intended. Furthermore, there is a growing
expectation that products distributed internationally will continue to be
operational and serviceable for an acceptable period of time.
The international standards for meeting these quality goals are ISO 9000
certification and CE marking of products and Chad Therapeutics has recently been
approved for both of these standards. In pursuit of an increasingly successful
role in the global economy Chad has been constantly improving its quality system
to meet or exceed these standards. Thus, as Chad's quality system moves through
improvement phases, so does the Company's opportunity for success in the
competitive global marketplace.
With the ISO 9000 certification Chad is improving efficiency, reducing costs and
most importantly increasing customer satisfaction. The CE Marking is the
manufacturer's self-declaration, showing compliance with all applicable EC
directives. For most products sold in the European Union (EU), the use of the CE
Marking and the Declaration of Conformity are mandatory as of June 1998. With
this mark of conformity, Chad's products can be marketed freely throughout the
member countries.
In today's marketplace there are many benefits resulting from ISO 9000
certification and CE Marking of products. Chad Therapeutics is committed to
maintaining the highest possible quality standards so that our products are in
the best possible competitive position.
8
<PAGE> 6
FINANCIAL HIGHLIGHTS
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Net Sales $16,593,000 26,161,000 20,359,000 14,518,000 9,470,000
Interest Income 164,000 113,000 97,000 50,000 28,000
Net Earnings 797,000 5,035,000 4,310,000 2,606,000 2,053,000
Basic Earnings Per Share .08 .51 .44 .26 .20
Diluted Earnings Per Share .08 .49 .42 .26 .20
Net Working Capital 10,704,000 10,985,000 9,219,000 5,172,000 4,176,000
Total Assets 17,436,000 15,861,000 10,778,000 6,371,000 5,075,000
Shareholders' Equity 16,074,000 15,110,000 9,775,000 5,574,000 4,507,000
</TABLE>
No cash dividends have been declared or paid during the periods presented.
9
<PAGE> 7
BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
--------------------------------
1998 1997
------------ ----------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 1,579,000 2,289,000
Accounts receivable, less allowance for doubtful
accounts of $105,000 and $107,000 in 1998 and 1997 2,469,000 2,329,000
Inventories (Note 2) 7,133,000 6,063,000
Income taxes refundable (Note 3) 572,000 527,000
Prepaid expenses 249,000 172,000
Deferred income taxes (Note 3) 64,000 356,000
------------ ----------
Total current assets 12,066,000 11,736,000
------------ ----------
Property and equipment, at cost:
Office equipment and furniture 1,639,000 1,265,000
Machinery and equipment 804,000 634,000
Tooling 1,084,000 305,000
Leasehold improvements 1,748,000 1,640,000
------------ ----------
5,275,000 3,844,000
Less accumulated depreciation and amortization 1,310,000 717,000
------------ ----------
Net property and equipment 3,965,000 3,127,000
------------ ----------
Note receivable from related party (Note 4) 126,000 --
Other assets, net (Note 5) 1,279,000 998,000
------------ ----------
$ 17,436,000 15,861,000
============ ==========
</TABLE>
<TABLE>
<CAPTION>
1998 1997
------------ ---------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 730,000 344,000
Accrued expenses (Note 8) 632,000 407,000
------------ ---------
Total current liabilities 1,362,000 751,000
------------ ---------
Commitments (Note 9)
Shareholders' equity (Note 6):
Common shares
Authorized 40,000,000 shares;
10,008,000 and 9,951,000 shares issued 13,100,000 12,834,000
Retained earnings 3,105,000 2,308,000
------------ ----------
16,205,000 15,142,000
Less treasury shares at cost, 19,000 and 3,000
shares in 1998 and 1997 (131,000) (32,000)
------------ ----------
Net shareholders' equity 16,074,000 15,110,000
------------ ----------
$ 17,436,000 15,861,000
============ ==========
</TABLE>
See accompanying notes to financial statements.
<PAGE> 8
STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------
1998 1997 1996
----------- ---------- ----------
<S> <C> <C> <C>
Net sales $16,593,000 26,161,000 20,359,000
Cost of sales 8,670,000 11,356,000 8,480,000
----------- ---------- ----------
Gross profit 7,923,000 14,805,000 11,879,000
Costs and expenses:
Selling, general and administrative 6,042,000 5,595,000 4,791,000
Research and development 713,000 910,000 113,000
----------- ---------- ----------
Total costs and expenses 6,755,000 6,505,000 4,904,000
----------- ---------- ----------
Operating income 1,168,000 8,300,000 6,975,000
Interest income 164,000 113,000 97,000
----------- ---------- ----------
Earnings before income taxes 1,332,000 8,413,000 7,072,000
Income taxes (Note 3) 535,000 3,378,000 2,762,000
----------- ---------- ----------
Net earnings $ 797,000 5,035,000 4,310,000
=========== ========== ==========
Basic earnings per share $ .08 .51 .44
=========== ========== ==========
Diluted earnings per share $ .08 .49 .42
=========== ========== ==========
</TABLE>
See accompanying notes to financial statements.
<PAGE> 9
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31,1998,1997 AND 1996
<TABLE>
<CAPTION>
RETAINED
COMMON SHARES (NOTE 6) EARNINGS
------------------------------- (ACCUMULATED TREASURY
SHARES AMOUNT DEFICIT) SHARES
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
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 -- -- -- 160,000
Exercise of Stock Options 74,000 187,000 -- --
Tax Benefit From Exercise of
Non-Qualified Stock Options -- 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 -- 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 -- 75,000 -- --
Net Earnings -- -- 5,035,000 --
---------- ------------ ------------ ------------
Balance at March 31, 1997 9,951,000 12,834,000 2,308,000 (32,000)
Common Shares Repurchased At Cost -- -- -- (285,000)
Common Shares Issued For Purchases
Under Employee Benefit Plan -- -- -- 186,000
Exercise of Stock Options 57,000 156,000 -- --
Tax Benefit From Exercise of
Non-Qualified Stock Options -- 103,000 -- --
Stock Option Grants -- 7,000 -- --
Net Earnings -- -- 797,000 --
---------- ------------ ------------ ------------
Balance at March 31, 1998 10,008,000 $ 13,100,000 $ 3,105,000 $ (131,000)
========== ============ ============ ============
</TABLE>
See accompanying notes to financial statements.
12
<PAGE> 10
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN CASH
YEARS ENDED March 31,
-------------------------------------------------
1998 1997 1996
----------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings $ 797,000 5,035,000 4,310,000
Adjustments to reconcile net earnings
to net cash provided by operating activities:
Depreciation and amortization 617,000 280,000 114,000
Compensation expense related
to option grants 7,000 -- --
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (140,000) 543,000 (746,000)
Decrease (increase) in inventories (1,070,000) (2,052,000) (2,166,000)
Decrease (increase) in income taxes refundable (45,000) (527,000) 84,000
Decrease (increase) in prepaid expenses (77,000) (27,000) (20,000)
Decrease (increase) in deferred income taxes 292,000 -- (202,000)
Decrease (increase) in note receivable
from related party (126,000) -- --
Decrease (increase) in other assets (305,000) (942,000) --
Increase (decrease) in accounts payable 386,000 (55,000) (115,000)
Increase (decrease) in accrued expenses 225,000 (17,000) (141,000)
Increase (decrease) in income taxes payable -- (180,000) 180,000
----------- --------- ---------
Net cash provided by operating activities 561,000 2,058,000 1,580,000
----------- --------- ---------
Cash flows from investing activities:
Decrease (increase) in marketable securities -- 1,029,000 (613,000)
Capital expenditures (1,431,000) (2,912,000) (268,000)
Dispositions of property and equipment -- 5,000 --
----------- --------- ---------
Net cash (used in) investing activities (1,431,000) (1,878,000) (881,000)
----------- --------- ---------
Cash flows from financing activities:
Tax benefit from exercise of non-qualified stock options 103,000 75,000 164,000
Exercise of stock options 156,000 216,000 187,000
Common shares purchased (285,000) (183,000) (620,000)
Common shares issued 186,000 224,000 160,000
Common shares tendered and retired -- (32,000) --
----------- --------- ---------
Net cash provided by (used in) financing activities 160,000 300,000 (109,000)
----------- --------- ---------
Net increase (decrease) in cash (710,000) 480,000 590,000
Cash beginning of year 2,289,000 1,809,000 1,219,000
----------- --------- ---------
Cash end of year $ 1,579,000 2,289,000 1,809,000
=========== ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $ 185,000 4,010,000 2,535,000
=========== ========= =========
Supplemental schedule of noncash investing
and financing activities:
Common stock issued as payment of dividend $ -- 5,779,000 --
=========== ========= =========
</TABLE>
See accompanying notes to financial statements.
13
<PAGE> 11
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1998
(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 carrying amounts of financial instruments approximate fair value as of March
31, 1998. 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. It is not practicable to
estimate the fair value of the note receivable from related party due to the
nature of the instrument.
INVENTORIES
Inventories are valued at lower of cost or market. Cost is determined based on
standard cost which approximates the first-in, first-out method.
DEPRECIATION
Depreciation of property and equipment is provided using straight-line methods
based on the estimated useful lives of the related assets as follows:
<TABLE>
<S> <C>
Office Equipment and Furniture 5-7 Years
Machinery and Equipment 5-10 Years
Tooling 3 Years
</TABLE>
Amortization of leasehold improvements 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 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 1997. 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 is also
required. The adoption of FAS 128 did not have a material impact on the
Company's financial position or results of operations.
Following is a reconciliation of the numerators and denominators used in the
calculation of basic and diluted net earnings per common share for the years
ended March 31, 1998, 1997 and 1996, respectively:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Basic net earnings per share
Numerator - net earnings $ 797,000 5,035,000 4,310,000
Denominator - common
shares outstanding 9,958,000 9,931,000 9,853,000
----------- ----------- -----------
Basic net earnings per share $ .08 $ .51 $ .44
=========== =========== ===========
Diluted net earnings per share
Numerator - net earnings $ 797,000 5,035,00 4,310,000
Denominator -
Common shares outstanding 9,958,000 9,931,000 9,853,000
Common stock options 256,000 442,000 367,000
----------- ----------- -----------
10,214,000 10,373,000 10,220,000
----------- ----------- -----------
Diluted net earnings per share $ .08 $ .49 $ .42
=========== =========== ===========
</TABLE>
Options to purchase 407,000 shares of common stock at prices ranging from $9.75
to $13.471 per share were not included in the computation of diluted earnings
per share in 1998 because the option price was greater than the average market
price of the common shares.
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 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 the years in which those temporary differences are expected
to be recovered or settled. The
14
<PAGE> 12
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
11% and 18% of net sales during the years ended March 31, 1998 and 1997,
respectively. No one customer exceeded 10% of net sales during 1996.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year's balances to conform
to the 1998 presentation.
STOCK OPTION PLAN
Prior to April 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations.
As such, compensation expense would be recorded on the date of the grant only if
the current market price of the underlying stock exceeded the exercise price. On
April 1, 1996, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 123, Accounting for Stock-Based Compensation, which permits entities
to recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows
entities to continue to apply the provisions of APB Opinion No. 25 and provide
pro forma net income and pro forma earnings per share disclosures for employee
stock option grants made in 1995 and future years as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
NEWLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued Statement No. 130, "Reporting
Comprehensive Income" ("FAS 130"), in June 1997. FAS 130 establishes standards
for reporting and display of comprehensive income and its components in
financial statements. FAS 130 is effective for both interim and annual periods
beginning after December 15, 1997. The Company will adopt FAS 130 in the first
quarter of the fiscal year ending March 31, 1999. Management believes that the
adoption of FAS 130 will not have a material impact on the Company's financial
position or results of operations.
The Financial Accounting Standards Board issued Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("FAS 131"), in June
1997. FAS 131 establishes standards for the way public business enterprises are
to report information about operating segments in annual financial statements
and requires enterprises to report selected information about operating segments
in interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. It replaces the "industry segment" concept of FAS No. 14,
"Financial Reporting for Segments of a Business Enterprise", with a "management
approach" concept as to basis for identifying reportable segments. FAS 131 is
effective for financial statements for periods beginning after December 15,
1997. The Company will adopt FAS 131 in the annual financial statements of the
fiscal year ending March 31, 1999. Management believes the adoption of FAS 131
will not have a material impact on the Company's financial position or results
of operations.
(2) INVENTORIES
At March 31, 1998 and 1997, inventories consisted of the following:
<TABLE>
<CAPTION>
1998 1997
---------- ---------
<S> <C> <C>
Finished goods $1,154,000 1,228,000
Work in process 1,117,000 1,454,000
Raw materials
and supplies 4,862,000 3,381,000
---------- ---------
$7,133,000 6,063,000
========== =========
</TABLE>
(3) INCOME TAXES
The provision for income taxes for fiscal 1998, 1997 and 1996 consists of the
following:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Current:
Federal $ 137,000 2,609,000 2,288,000
State 106,000 769,000 676,000
---------- ---------- ----------
243,000 3,378,000 2,964,000
Deferred:
Federal 274,000 (10,000) (181,000)
State 18,000 10,000 (21,000)
---------- ---------- ----------
292,000 -- (202,000)
---------- ---------- ----------
Total $ 535,000 3,378,000 2,762,000
========== ========== ==========
</TABLE>
A reconciliation of the difference between the Company's provision for income
taxes and the statutory income tax for the years ended March 31, 1998, 1997 and
1996, respectively, is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Statutory tax expense $ 453,000 2,860,000 2,404,000
State income tax 82,000 514,000 432,000
Warranty and other -- 4,000 (74,000)
---------- ---------- ----------
$ 535,000 3,378,000 2,762,000
========== ========== ==========
</TABLE>
15
<PAGE> 13
The tax effects of temporary differences a give rise to significant portions of
the deferred tax assets at March 31, 1998 and 1997 are presented as follows:
<TABLE>
<CAPTION>
1998 1997
-------- -------
<S> <C> <C>
State taxes $ 29,000 265,000
Bad debt reserves 36,000 46,000
Accrued expenses 57,000 36,000
Inventories 23,000 21,000
-------- -------
Total deferred tax assets $145,000 368,000
Deferred tax liability - depreciation (81,000) (12,000)
-------- -------
Net deferred tax assets $ 64,000 356,000
======== =======
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. Based upon the levels of historical taxable income,
management believes that it is more likely than not, that the Company will
realize the deferred tax assets. As such, no valuation allowance has been
recorded.
(4) NOTE RECEIVABLE FROM RELATED PARTY
The note receivable from related party is due from an officer and is payable in
monthly installments of $1,200 with interest at 7.25%, is secured by a second
trust deed and is due in April, 2112.
(5) OTHER ASSETS
Other assets includes $1,250,000 paid in 1997 and 1998 for a license on a new
product. The license fee is being amortized beginning in 1998 using the
straight-line method over the life of the related patents, 14 years.
(6) SHAREHOLDERS' EQUITY
In 1998,1997 and 1996 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).
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, 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) (152,000) 5.67
-------- ----------- -----
Outstanding -
March 31, 1997 566,000 3,698,000 6.53
Cancelled (30,000) (372,000) 12.40
Granted 254,000 2,492,000 9.81
Exercised (2,000) (10,000) 5.98
-------- ----------- -----
Outstanding -
March 31, 1998 788,000 $ 5,808,000 7.37
======== =========== =====
Exercisable -
March 31, 1998 372,000 $ 2,107,000 5.66
======== =========== =====
Non-qualified Options:
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
Granted 26,000 267,000 10.27
Exercised (55,000) (146,000) 2.66
-------- ----------- -----
Outstanding -
March 31, 1998 153,000 $ 1,388,000 9.07
======== =========== =====
Exercisable -
March 31, 1998 123,000 $ 1,111,000 9.03
======== =========== =====
</TABLE>
At March 31, 1998, information regarding outstanding options is summarized as
follows:
<TABLE>
<S> <C> <C>
Range of exercise prices $1.68-6.69 8.75-13.47
Number outstanding 519,000 422,000
Weighted average
remaining life (yrs.) 6.7 8.9
Weighted average
exercise price $ 5.13 $ 10.77
Number exercisable 390,000 105,000
Weighted average
exercise price $ 4.56 $ 12.26
</TABLE>
16
<PAGE> 14
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 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 1998, 1997 and 1996 would have
been reduced by approximately $247,000, $214,000 and $100,000, respectively, and
net earnings per share would have been reduced by $.02, $.02 and $.01 per share
in 1998, 1997 and 1996, respectively. The weighted average fair value of options
granted during 1998, 1997 and 1996 is estimated at $5.41, $2.83 and $5.69,
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>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Risk-free interest rate 5.9% 5.9% 6.2%
Forfeiture rate 2.0% 2.0% 2.0%
Dividend yield .0 .0 .0
Volatility 57% 45% 45%
Expected life (years) 5.0 5.0 5.0
</TABLE>
(7) 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 $59,000, $96,000, and $71,000 of the plan contributions during
1998, 1997 and 1996, respectively.
(8) ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Accrued royalties $144,000 116,000
Deferred revenue 98,000 --
Product and business
liability insurance 41,000 67,000
Deferred rent 92,000 97,000
Accrued vacation 76,000 72,000
Other 181,000 55,000
-------- --------
$632,000 407,000
======== ========
</TABLE>
(9) COMMITMENTS
The Company is currently leasing its administrative and plant 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>
1999 $ 368,000
2000 356,000
2001 344,000
2002 354,000
2003 368,000
Thereafter 93,000
----------
TOTAL: $1,883,000
==========
</TABLE>
Rent expense amounted to $440,000, $417,000, and $239,000 for the years ended
March 31, 1998, 1997 and 1996, respectively.
(10) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents summarized unaudited quarterly financial data for
1998 and 1997:
<TABLE>
<CAPTION>
NET BASIC
GROSS EARNINGS EARNINGS(LOSS)
REVENUE PROFIT (LOSS) PER SHARE
----------- ----------- ----------- --------------
<S> <C> <C> <C> <C>
1998
----
First Quarter $ 5,428,000 $ 2,985,000 $ 804,000 $0.08
Second Quarter 4,390,000 2,214,000 289,000 0.03
Third Quarter 3,234,000 1,324,000 (286,000) (0.03)
Fourth Quarter 3,541,000 1,400,000 (10,000) 0.00
----------- ----------- ----------- -----
Year $16,593,000 $ 7,923,000 $ 797,000 $0.08
=========== =========== =========== =====
1997
----
First Quarter $ 7,772,000 $ 4,593,000 $ 1,624,000 $0.17
Second Quarter 7,357,000 4,257,000 1,610,000 0.16
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 $0.51
=========== =========== =========== =====
</TABLE>
(11) SUBSEQUENT EVENT
On May 7, 1998, the Company entered into an agreement with it's bank to provide
a line of credit for one year of $2,000,000 for working capital to expand the
new TOTAL 0[subscript]2 Delivery System product line. Amounts borrowed under the
line of credit will bear interest at the bank's prime rate and is payable
monthly.
17
<PAGE> 15
INDEPENDENT AUDITOR'S 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, 1998 and 1997 and the related statements of earnings, shareholders'
equity and cash flows for the three years ended March 31, 1998. 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, 1998 and 1997 and the results of its operations and its cash flows for the
three years ended March 31, 1998, in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
Los Angeles, California
May 1, 1998, except as to Note 11
which is as of May 7, 1998
18
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Sales for the years ended March 31, 1998 and 1997, decreased $9,568,000 (36.6%)
and increased $5,802,000 (28.5%), respectively, from the prior year's periods.
There were no price changes during 1997 and 1996. While there have been limited
price reductions in 1998, the decrease in sales relates primarily to decreases
in domestic unit sales in 1998 of OXYMATIC conservers and OXYLITE complete
portable oxygen systems which are being affected by the current marketing
environment for home oxygen therapy discussed below.
Sales to foreign distributors represented 10% of total sales for the years'
ended March 31, 1998 and 1997. Currently, management expects a small increase in
sales to foreign distributors during the upcoming fiscal year and quarter to
quarter sales will fluctuate depending on the timing of shipments. In addition,
all foreign sales are transacted in dollars, thus annual unit sales could be
affected by foreign currency fluctuations.
The current procedure for reimbursement by Medicare for home oxygen services
provides a prospective flat fee monthly payment based solely on the patient's
prescribed oxygen requirement. Under this system, 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 these reimbursement procedures have heightened
interest in the cost savings and improved 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.
Three major national chains accounted for approximately 24% and 31% of the
Company's domestic sales for the years ended March 31, 1998 and 1997,
respectively. Margins on these sales may be somewhat lower due to quantity
pricing. In some instances this has resulted in reduced purchases as the former
independent provider complies with the chain's purchasing policies. 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 revenues at the end of fiscal 1997 and during the
year ended March 31, 1998, were affected by several factors. During the year
ended March 31, 1998, management believes sales to national chain accounts
decreased as programs to convert patients to more acceptable ambulatory systems
in the previous year 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 were being discussed as part of the
Federal budget process. This process has now been finalized and a 25% cut in
home oxygen reimbursement went into effect January, 1998. The effects of managed
care and concerns over the severity of reimbursement cuts has, in many cases,
resulted in the provision of systems to patients that do not provide truly
ambulatory oxygen. Management believes these factors, including uncertainties as
to how home care providers will respond to the 25% cut, may continue to
adversely affect the Company's revenues from sales of oxygen conserving devices
for the foreseeable future.
Management also believes future revenues may be positively affected by sales of
a new product, the TOTAL 0[subscript]2(TM) Delivery System. The TOTAL
0[subscript]2 system provides stationary oxygen for patients at home, portable
oxygen including an oxygen conserving device for ambulation and a safe and
efficient mechanism for filling portable oxygen cylinders. This should provide
home care dealers with a means to deal with the reimbursement cuts discussed
above by reducing their monthly cost of servicing patients while at the same
time providing a higher quality of service by maximizing ambulatory capability.
The Company received clearance in November 1997, to sell the new product from
the Food and Drug Administration. The Company began shipping TOTAL 0[subscript]2
systems in January and realized approximately $535,000 in sales through March
31, 1998. The sales potential for the new system is significant as the average
selling price is anticipated to be approximately four times that of the OXYMATIC
and OXYLITE systems. No estimate can currently be made regarding the level of
success the Company may achieve with the TOTAL 0[subscript]2 system.
Cost of sales as a percent of net sales increased from 43.4% to 52.3% and from
41.7% to 43.4%, respectively, for the years ended March 31, 1998 and 1997, as
compared to the prior year's periods. Both years have been affected by higher
fixed overhead costs associated with the Company's move to new facilities in
October, 1996. In addition, the year ended March 31, 1998, has been affected by
decreased sales volume and start-up costs associated with the manufacture of the
TOTAL 02 system. Management believes the gross margins should remain at or near
current levels in future periods.
19
<PAGE> 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Selling, general and administrative expenditures increased from $5,595,000 to
$6,042,000 and from $4,791,000 to $5,595,000 for the years ended March 31, 1998
and 1997, respectively. These increases related to the Company's move to new
facilities in October 1996, and the costs of preparing to bring the Company's
new TOTAL 02 system product to market. The Company does not anticipate a
decrease in these expenses in the coming years. Research and development
expenses decreased by $197,000 for the year ended March 31, 1998, as compared to
the prior year's period. Currently, management expects research and development
costs to total approximately $800,000 in the fiscal year ended March 31, 1999,
on projects to enhance and expand the Company's product line.
FINANCIAL CONDITION
At March 31, 1998, the Company had cash totaling $1,579,000 or 9% of total
assets, as compared to $2,289,000 (14%) at March 31, 1997. Net working capital
decreased from $10,985,000 at March 31, 1997, to $10,704,000 at March 31, 1998.
Accounts receivable increased $140,000 during the year ended March 31, 1998.
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 $1,070,000. This increase relates
primarily to raw materials purchased for the manufacture of the new TOTAL 02
product line. 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. However, should the Company achieve rapid
market penetration with the new TOTAL 02 product line it may need additional
funds on a short term basis. The Company has entered into an agreement with its
bank to provide a line of credit for up to $2,000,000 if such funds are
necessary for expansion of the TOTAL 02 product line. The Company expects
capital expenditures during the next twelve months to be approximately $750,000.
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, 1998, 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 transactions. During the year ended
March 31, 1998, the Company purchased approximately 38,000 shares at a cost of
$285,000, however, the number of shares which may be purchased under these
programs in the future can not be predicted at this time. The Company does not
provide post employment retirement benefits.
YEAR 2000
Management has initiated an enterprise-wide program to prepare the Company's
computer systems and applications for the year 2000. The Company expects to
incur internal staff costs as well as consulting and other expenses related to
infrastructure and facilities enhancements necessary to prepare the systems for
the year 2000. The cost of testing and conversion of system applications is
expected to be minimal. A significant proportion of these costs are not likely
to be incremental costs to the Company, but rather will represent the
redeployment of existing information technology resources.
NEWLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued Statement No. 130, "Reporting
Comprehensive Income" ("FAS 130"), in June 1997. FAS 130 establishes standards
for reporting and display of comprehensive income and its components in
financial statements. FAS 130 is effective for both interim and annual periods
beginning after December 15, 1997. The Company will adopt FAS 130 in the first
quarter of the fiscal year ending March 31, 1999. Management believes that the
adoption of FAS 130 will not have a material impact on the Company's financial
position or results of operations.
The Financial Accounting Standards Board issued Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("FAS 131"), in June
1997. FAS 131 establishes standards for the way public business enterprises are
to report information about operating segments in annual financial statements
and requires enterprises to report selected information about operating segments
in interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. It replaces the "industry segment" concept of FAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," with a "management
approach" concept as to basis for identifying reportable segments. FAS 131 is
effective for financial statements for periods beginning after December 15,1997.
The Company will adopt FAS 131 in the annual financial statements of the fiscal
year ending March 31, 1999. Management believes the adoption of FAS 131 will not
have a material impact on the Company's financial position or results of
operations.
20
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND 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.
The Company's future growth in the near term will depend in significant part
upon the commercial success of the TOTAL 02 Delivery System. The success of this
new product will depend upon the health care community's perception of the
system's capabilities, clinical efficacy and benefit to patients. In addition,
prospective sales will be impacted by the degree of acceptance it achieves among
home oxygen dealers and patients requiring supplementary oxygen. As with the
introduction of any new product, the Company's ability to successfully promote
the TOTAL 02 Delivery System cannot be assessed at this time.
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 24% 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. While the Company believes the quality of its products and
its established reputation will continue to be a competitive advantage, some
competitors have successfully introduced lower price products which do not
provide oxygen conserving capabilities comparable to the Company's products and
no assurance can be given that increased competition in the home oxygen market
will not continue to have an adverse effect on the Company's 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 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 meaningful 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. It cannot be predicted how
changes in reimbursement levels will affect the home oxygen industry and there
can be no assurance that such changes 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 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
21
<PAGE> 19
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 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> 20
CORPORATE DATA
OFFICERS
CHARLES R. ADAMS
Chairman
THOMAS E. JONES
Chief Executive Officer
FRANCIS R. FLEMING
President and
Chief Operating Officer
EARL L. YAGER
Senior Vice President,
Chief Financial Officer and Secretary
OSCAR J. SANCHEZ
Vice President, Development and
Engineering
LOUIE GORYOKA
Vice President, Quality Assurance
and Regulatory Affairs
DIRECTORS
CHARLES R. ADAMS
Chairman
Chad Therapeutics, Inc.
THOMAS E. JONES
Chief Executive Officer
Chad Therapeutics, Inc.
FRANCIS R. FLEMING
President
Chad Therapeutics, Inc.
EARL L. YAGER
Senior Vice President
Chad Therapeutics, Inc.
DAVID L. CUTTER
Retired Chairman Of The Board
Cutter Laboratories, Inc.
NORMAN COOPER
Retires Chairman
Kallir, Philips, Ross, Inc.
JOHN C. BOYD
Retired
PHILIP T. WOLFSTEIN
President
Wolfstein International, Inc.
CORPORATE DATA
CORPORATE HEADQUARTERS
21622 Plummer Street
Chatsworth, CA 91311
(818) 882-0883
LEGAL COUNSEL
Graham & James LLP
AUDITORS
KPMG Peat Marwick LLP
Los Angeles, California
TRANSFER AGENT AND REGISTRAR
American Stock Transfer Company
40 Wall Street
New York, NY 10005
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 l
split distributed October 15, 1993, and a 3 for 2 split distributed on October
16, 1995.
<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
- ----------------------------------------------------
<S> <C> <C>
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
June 30, 1997 12 5-3/4
September 30, 1997 12-3/16 7-5/8
December 31, 1997 12-5/16 8-7/8
March 31, 1998 9-5/16 6-1/4
</TABLE>
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 12, 1998, there were approximately 311
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 1,
1998, except for note 11 which is as of May 7, 1998, relating to the balance
sheets of Chad Therapeutics, Inc. as of March 31, 1998 and 1997, and the related
statements of earnings, shareholders' equity, and cash flows for each of the
years in the three-year period ended March 31, 1998, which report appears in the
March 31, 1998, annual report on Form 10-K of Chad Therapeutics, Inc.
KPMG Peat Marwick LLP
Los Angeles, California
June 16, 1998
<PAGE> 1
[LOGO] EXHIBIT 28.7
[DEPARTMENT OF HEALTH & HUMAN SERVICES LETTERHEAD]
Mr. Louie Goryoka
Chad Therapeutics, Inc.
21622 Plummer Street
Chatsworth, CA 91311
Re: K971889
Chad TOTAL 0[subscript]2 Delivery System
Regulatory Class: II (two)
Product Code: 73 CAW
Dated: August 19, 1997
Received: August 20, 1997
Dear Mr. Goryoka:
This letter corrects our substantially equivalent letter of November 17, 1997,
regarding the error in the name of the contact person.
We have reviewed your Section 510(k) notification of intent to market the device
referenced above and we have determined the device is substantially equivalent
(for the indications for use stated in the enclosure) to devices marketed in
interstate commerce prior to May 28, 1976, the enactment date of the Medical
Device Amendments or to devices that have been reclassified in accordance with
the provisions of the Federal Food, Drug, and Cosmetic Act (Act). You may,
therefore, market the device, subject to the general controls provisions of the
Act. The general controls provisions of the Act include requirements for annual
registration, listing of devices, good manufacturing practice, labeling, and
prohibitions against misbranding and adulteration.
If your device is classified (see above) into either class II (Special Controls)
or class III (Premarket Approval) it may be subject to such additional controls.
Existing major regulations affecting your device can be found in the Code of
Federal Regulations, Title 21, Parts 800 to 895. A substantially equivalent
determination assumes compliance with the Good Manufacturing Practice for
Medical Devices: General (GMP) regulation (21 CFR Part 820) and that, through
periodic GMP inspections, FDA will verify such assumptions. Failure to comply
with the GMP regulation may result in regulatory action. In addition, the Food
and Drug Administration (FDA) may publish further announcements
<PAGE> 2
concerning your device in the Federal Register. Please note: this response to
your premarket notification submission does not affect any obligation you might
have under sections 531 through 542 of the Act for devices under the Electronic
Product Radiation Control provisions, or other Federal laws or regulations.
This letter will allow you to begin marketing your device as described in your
510(k) premarket notification. The FDA finding of substantial equivalence of
your device to a legally marketed predicate device results in a classification
for your device and thus, permits your device to proceed to the market.
If you desire specific advice for your device on our labeling regulation (21
CFR Part 801 and additionally 809.10 for in vitro diagnostic devices), please
contact the Office of Compliance at (301) 594-4648. Additionally, for questions
on the promotion and advertising of your device, please contact the Office of
Compliance at (301) 594-4639. Also, please note that the regulation entitled,
"Misbranding by reference to premarket notification" (21 CFR 807.97). Other
general information on your responsibilities under the Act may be obtained from
the Division of Small Manufacturers Assistance at their toll free number (800)
638-2041 or at (301) 443-6597 or at its internet address
"http://www.fda.gov/cdrh/dsmamain.html".
Sincerely yours,
/s/ Thomas J. Callahan
Thomas J. Callahan, Ph.D.
Director
Division of Cardiovascular, Respiratory,
and Neurological Devices
Office of Device Evaluation
Center for Devices and
Radiological Health
<TABLE> <S> <C>
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 1,579
<SECURITIES> 0
<RECEIVABLES> 2,469
<ALLOWANCES> 0
<INVENTORY> 7,133
<CURRENT-ASSETS> 12,066
<PP&E> 5,275
<DEPRECIATION> 1,310
<TOTAL-ASSETS> 17,436
<CURRENT-LIABILITIES> 1,362
<BONDS> 0
13,100
0
<COMMON> 0
<OTHER-SE> 2,974
<TOTAL-LIABILITY-AND-EQUITY> 17,436
<SALES> 16,593
<TOTAL-REVENUES> 0
<CGS> 8,670
<TOTAL-COSTS> 6,755
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,332
<INCOME-TAX> 535
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 797
<EPS-PRIMARY> .08
<EPS-DILUTED> .08
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