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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, 1999
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 11, 1999 (based on the average over-the-counter bid
and asked prices of such stock on such date) was $17,521,000.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of June 11, 1999:
Common Shares 10,012,000
Portions of the Registrant's definitive Proxy Statement for its September
14, 1999, 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, 1999 ("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.
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 was implemented in
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 two years
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.
OXYMATIC Electronic Oxygen Conservers. The Company began marketing the
OXYMATIC conserver in March, 1986. This product is a small electronic device,
designed for use with portable oxygen systems. The OXYMATIC conserver
electronically senses the optimal
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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.
Sales of OXYMATIC conservers and the OXYLITE systems discussed below
accounted for approximately 72% of the Company's sales in 1999.
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.
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
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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.
TOTAL O(2) Delivery System. In January, 1998, the Company began
marketing the TOTAL O(2)(TM) 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.
Initial sales of the TOTAL O(2) system have been adversely affected by
several factors, including the overall home oxygen market climate as well as
start-up manufacturing and related supplier quality issues. The Company has
taken a number of steps recently to resolve the manufacturing and supplier
issues. 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 O(2) system. See Outlook:Issues & Risks - New Product in
the Company's Annual Report to Shareholders.
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 O(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.
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 O2 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, 1999, the Company expended approximately
$625,000 on research and development and has expended approximately $3,301,000
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 $525,000 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%
and requires minimum annual royalties of $100,000, $300,000 and $500,000 in the
third, fourth and sebsequent years, respectively. 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.
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The Company believes that other injection molding facilities would be available
in the event of a termination of this arrangement.
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 O(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 and requires payment within a time frame consistent with
industry standards.
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
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prescribed exercise programs and help them to achieve the therapeutic benefits
of maintaining a lifestyle as normal as possible. Patients, most of whom are
free to select their oxygen supplier, are reportedly receptive to changing
suppliers in order to obtain equipment that will allow them to travel and
maintain their quality of life.
Approximately 80% of all home oxygen patients are covered by Medicare
and other government 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 Director of Sales & Marketing, a
marketing assistant, a National Sales Manager and six in-house sales and
customer service representatives who are in regular and frequent proactive
telephone sales contact with customers and potential customers. In addition, the
Company has recently developed a field sales force of independent manufacturers
sales representatives to handle direct selling to customers. This field sales
force is currently comprised of 40 individuals with coverage throughout the
United States. The Company also utilizes 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
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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.
The Company has entered into exclusive distributorship agreements in
Germany, Canada, Japan, and Australia. The Company's 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 accounted for 11% and 18% of the Company's revenues in
1998 and 1997, respectively. No one customer exceeded 10% of net sales in 1999.
Financial Information Relating to Foreign and
Domestic Operations and Export Sales
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Sales (thousands):
United States $12,350 14,866 23,567
Germany 642 632 1,146
All other countries 1,072 1,095 1,448
------- ------- -------
Total $14,064 16,593 26,161
======= ======= =======
</TABLE>
All identifiable assets are located in the United States.
At March 31, 1999, the Company had no backlog of orders for any of its
products. The Company presently intends to maintain a large enough inventory to
ship all of its products immediately upon receipt of orders. The Company
believes that such an inventory is necessary to meet the requirements of its
customers.
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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, although some have attained
market share at the Company's expense.
There are several other types of portable oxygen systems which compete
with the Company's OXYLITE systems but do not utilize oxygen conserving devices.
Aluminum and steel oxygen cylinders with continuous flow are utilized by some
oxygen suppliers as portable systems. Although they do provide users with some
portability, their size and bulk limits their use by patients who need or want
to be truly ambulatory. The most commonly used of these cylinders is
approximately three feet high, weighs over 20 lbs., and provides an average
patient with less than 5 hours of oxygen. These systems are enjoying some level
of success due to
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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 (often 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 O(2) 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, accordingly, the degree of protection afforded by foreign patents may be
more or less than in the United States.
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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 O(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 O2 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 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.
16
<PAGE> 17
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 O(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 O(2) Delivery System as
Class II devices.
Employees
As of June 11, 1999, CHAD had 78 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.
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.
17
<PAGE> 18
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. Although the Company believes its product liability
insurance is sufficient and no pending legal proceeding poses a material threat,
no assurance can be given that pending or future proceedings will not have a
material impact on the Company's financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity and Stockholder
Matters.
The information required herein is hereby incorporated by reference to
the information contained under the caption "Corporate Data" in the Company's
Annual Report.
Item 6. Selected Financial Data.
The information required herein is hereby incorporated by reference to
the information contained under the caption "Selected Financial Data" in the
Company's Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The information required herein is hereby incorporated by reference to
the information contained under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Company's
Annual Report.
Item 7a. Quantitative and Qualitative Disclosures about Risk
The Company has no significant risks in this area.
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, 1999 and 1998
Statements of Operations -- Years ended March 31, 1999, 1998
and 1997.
Statements of Shareholders' Equity -- Years ended March 31,
1999, 1998 and 1997.
Statements of Cash Flows -- Years ended March 31, 1999, 1998
and 1997.
Notes to Financial Statements.
(a) (2) Financial Statement Schedules.
See Notes to Financial Statements.
(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 O(2) 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 O(2) 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.
******* Previously filed as an exhibit to the Registrant's Annual Report on Form
10-K for the year ended March 31, 1998.
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 23rd day of June, 1999.
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 23, 1999
- --------------------- President and Director
Thomas E. Jones (Principal Executive Officer)
/s/Earl L. Yager Executive Vice President, June 23, 1999
- --------------------- Chief Financial Officer
Earl L. Yager and Secretary and Director
(Principal Financial and
Accounting Officer)
Chairman Emeritus June 23, 1999
- ---------------------
Charles R. Adams
/s/David L. Cutter Director June 23, 1999
- ---------------------
David L. Cutter
/s/John C. Boyd Director June 23, 1999
- ---------------------
John C. Boyd
/s/Norman Cooper Director June 23, 1999
- ---------------------
Norman Cooper
/s/Philip Wolfstein Director June 23, 1999
- ---------------------
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, 1999
23.1 Consent of Independent Accountant
</TABLE>
24
<PAGE> 1
EXHIBIT 13.1
[CHAD THERAPEUTICS LOGO]
1999 ANNUAL REPORT
<PAGE> 2
LETTER FROM THE CEO
The year ended March 31, 1999 was a very difficult one for both Chad and the
home oxygen industry. The combined total of 30% in Medicare reimbursement cuts
that went into effect on January 1, 1998 and 1999, has created a significantly
changed marketing environment. Many homecare providers are no longer willing to
supply patients with oxygen systems that provide superior ambulation and are now
providing systems that have the least expensive acquisition cost. This, coupled
with increased competition, has caused the Company's OXYMATIC(R) conserver
products to lose market share. These market conditions have also provided a
challenging environment for the introduction of the TOTAL 0(2)(TM) Delivery
System. While these are formidable challenges, I will explain how we are
positioning Chad to improve our performance in the new environment.
One of our efforts in the past year has been to change our sales strategy by
developing a field sales organization of manufacturer's representatives to sell
our products. We entered into a joint venture with Salter Labs in July 1998 to
test this approach. We quickly found out that to be successful in this effort we
needed direct control of and communication with the manufacturer's
representatives. We terminated the Salter relationship and began recruiting and
training a Chad manufacturer's representative organization in October 1998.
Robert Mogue joined the Company as Director of Sales and Marketing to head up
this effort and I am happy to tell you that this task was completed in March of
1999. We now have 41 representatives throughout the United States selling our
respiratory products. These individuals are independent sales representatives
with experience in selling products to homecare providers and we look forward to
their contribution to our selling efforts in the upcoming year.
In addition to the challenges discussed above, we have faced other difficulties
with the introduction of the TOTAL 0(2) system that have prevented us from
achieving our goal of a smooth and efficient manufacturing operation for this
product. As described in our quarterly reports, we encountered several supplier
performance problems with components of the TOTAL 0(2) system. We worked
diligently to correct these problems and replaced two suppliers at the end of
1998. Solving these problems and taking corrective actions took a heavy toll
from a financial perspective, including inventory and related tooling
write-downs, as well as in the utilization of human resources. This also
contributed to the slowness of the market penetration for this product.
I am pleased to tell you, however, that the TOTAL 0(2) product is now performing
up to our expectations in the field. The evidence of this is the satisfaction of
our continually growing body of TOTAL 0(2) system users. As our field sales
force gains experience with our products, we look forward to increasing the rate
of market penetration for this product.
The problems discussed above not only undermined our efforts to achieve a smooth
introduction for this new product, but consumed much of the manpower available
to get the international version of the TOTAL 0(2) system redesigned, tested and
approved for the CE mark and sale in Europe. After several delays, we now expect
to submit our final documentation package within the next few weeks for this
important effort toward market expansion. At this point in time, we are working
towards introduction of this product in several international markets where
there have been indications of strong interest.
As mentioned above, the planned additional 5% cut in oxygen reimbursement by
Medicare came on schedule on January 1, 1999. While everyone in the home oxygen
business had known this was coming, the prevalent reaction was an additional
squeezing of purse strings and tightening of services to respiratory patients.
Homecare providers now, in many cases, supply the least expensive system without
regard to the amount of ambulation offered or the weight of the system. As a
result, in Chad's core product line of oxygen conservers, the market has become
highly competitive from both a price and patient benefit perspective. We will
therefore compete on these terms by expanding our product line and offering more
competitive pricing terms to prevent a further loss of market share. We expect
our field sales force to make a positive contribution in this effort in the
upcoming year.
While there continues to be a place in the market for the OXYMATIC conserver and
OXYLITE(R) systems, we are working to expand this product line and offer
homecare providers a number of choices to fit their oxygen conserver
3
<PAGE> 3
needs. We have two new products under development in this area and currently
anticipate announcing further developments regarding these products in the near
future.
We believe that there will continue to be pressure for healthcare cost
reductions in general and specifically for home oxygen reimbursement. While no
changes are imminent, competitive bidding and inherent reasonableness are two
means of establishing new methodology for oxygen pricing and payments that are
under consideration. Further reductions, if any, will underscore our need to
offer the most cost effective products to our homecare provider customers.
As a result, we continue to believe in the ultimate success of the TOTAL 0(2)
system. While the higher acquisition cost continues to be a barrier for some
homecare providers, for those willing to make the investment this system
represents the lowest life cycle cost product for providing oxygen to a
significantly ambulatory patient. In addition, it allows the home care provider
to offer a higher quality of service because the patient can control his own
supply of portable oxygen without being dependent on the provider's deliveries.
As home care providers learn to operate in the new reimbursement environment, we
believe they will turn more and more to the TOTAL 0(2) system as the most cost
effective way to provide home oxygen.
While our financial resources have been stretched in the past year, we presently
do not foresee the need for external financing in the upcoming year. We are
generating positive cash flow and will be receiving an income tax refund of
approximately $630,000 in July of 1999. A significant portion of our loss for
the year ended March 31, 1999, $886,000, resulted from the inventory write-downs
and related issues discussed earlier. We have taken a number of steps in the
past six months to restructure our operating expenses to be in line with our
current revenue expectations.
EXECUTIVE CHANGES
In March of 1999, Frank Fleming announced his retirement from Chad and he
subsequently resigned from the Board of Directors. Frank served the Company in
various capacities from its founding in 1982, including the office of President
from April 1995 to November 1998. We will miss his experience and valued
judgment on our Board and plan to draw on his considerable knowledge in his
ongoing role as a part time consultant to the Company. We wish him well in the
future.
In addition, at its March 22, 1999, meeting, the Board of Directors elected
Charles R. Adams, the founder, former Chief Executive Officer and Chairman of
the Board of Chad Therapeutics, Inc., to the position of Chairman Emeritus in
recognition of his contributions and years of service to the Company.
CONCLUSION
In summary, during the fiscal year ending March 31, 2000, our number one
priority will be to return the Company to profitability. To this end, we plan to
accomplish several milestones regarding the market opportunity with the TOTAL
0(2) system. First, with the help of our newly trained manufacturer's sales
representative organization, we look forward to increasing the rate of market
penetration for this product. Second, we are working towards introduction of a
new version of the product internationally, which will bear the CE mark. In
addition, we have identified and plan to implement numerous cost reduction
efforts for this product as soon as current raw material stock is depleted. With
respect to expanding our oxygen conserver line and related products, we are
working towards introduction of two new products, developed internally. These
introductions are designed to regain market share in this area and could
positively affect fiscal year 2000 revenues.
All of us at Chad appreciate your patience during this period. We thank you for
your support and will continue to do everything in our power to restore Chad's
profitability and generate positive growth in revenues.
Thomas E. Jones
/s/ THOMAS E. JONES
Chief Executive Officer
4
<PAGE> 4
SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Net Sales $ 14,064,000 $ 16,593,000 26,161,000 20,359,000 14,518,000
Interest Income 41,000 164,000 113,000 97,000 50,000
Net Earnings (loss) (1,464,000) 797,000 5,035,000 4,310,000 2,606,000
Basic Earnings (loss) Per Share (.15) .08 .51 .44 .26
Diluted Earnings (loss) Per Share (.15) .08 .49 .42 .26
Net Working Capital 10,164,000 10,704,000 10,985,000 9,219,000 5,172,000
Total Assets 15,899,000 17,436,000 15,861,000 10,778,000 6,371,000
Shareholders' Equity 14,693,000 16,074,000 15,110,000 9,775,000 5,574,000
</TABLE>
No cash dividends have been declared or paid during the periods presented.
5
<PAGE> 5
BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
---------------------------
ASSETS 1999 1998
----------- -----------
<S> <C> <C>
Current assets:
Cash $ 137,000 1,579,000
Accounts receivable, less allowance for doubtful
accounts of $88,000 and $105,000 in 1999 and 1998 2,165,000 2,469,000
Inventories (Note 2) 7,642,000 7,133,000
Income taxes refundable (Note 3) 687,000 572,000
Prepaid expenses 294,000 249,000
Deferred income taxes (Note 3) 445,000 64,000
----------- -----------
Total current assets 11,370,000 12,066,000
----------- -----------
Property and equipment, at cost:
Office equipment and furniture 1,688,000 1,639,000
Machinery and equipment 830,000 804,000
Tooling 1,066,000 1,084,000
Leasehold improvements 1,782,000 1,748,000
----------- -----------
5,366,600 5,275,000
Less accumulated depreciation and amortization 2,086,000 1,310,000
----------- -----------
Net property and equipment 3,280,000 3,965,000
----------- -----------
Note receivable from related party (Note 4) 68,000 126,000
Other assets, net (Note 5) 1,181,000 1,279,000
----------- -----------
$15,899,000 17,436,000
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY 1999 1998
----------- -----------
<S> <C> <C>
Current liabilities:
Accounts payable $ 227,000 730,000
Accrued expenses (Note 8) 979,000 632,000
----------- -----------
Total current liabilities 1,206,000 1,362,000
----------- -----------
Commitments (Note 9)
Shareholders' equity (Note 6):
Common shares
Authorized 40,000,000 shares;
10,012,000 and 10,008,000 shares issued 13,052,000 13,100,000
Retained earnings 1,641,000 3,105,000
----------- -----------
14,693,000 16,205,000
Less treasury shares at cost, 19,000 in 1998 -- (131,000)
----------- -----------
Net shareholders' equity 14,693,000 16,074,000
----------- -----------
$15,899,000 17,436,000
=========== ===========
</TABLE>
See accompanying notes to financial statements.
6
<PAGE> 6
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 14,064,000 16,593,000 26,161,000
Cost of sales 9,768,000 8,670,000 11,356,000
------------ ------------ ------------
Gross profit 4,296,000 7,923,000 14,805,000
Costs and expenses:
Selling, general and administrative 6,119,000 6,042,000 5,595,000
Research and development 625,000 713,000 910,000
------------ ------------ ------------
Total costs and expenses 6,744,000 6,755,000 6,505,000
------------ ------------ ------------
Operating income (loss) (2,448,000) 1,168,000 8,300,000
Interest income, net 41,000 164,000 113,000
------------ ------------ ------------
Earnings (loss) before income taxes (2,407,000) 1,332,000 8,413,000
Income tax expense (benefit) (Note 3) (943,000) 535,000 3,378,000
------------ ------------ ------------
Net earnings (loss) $ (1,464,000) 797,000 5,035,000
============ ============ ============
Basic earnings (loss) per share $ (.15) .08 .51
============ ============ ============
Diluted earnings (loss) per share $ (.15) .08 .49
============ ============ ============
Weighted shares outstanding:
Basic 10,012,000 9,958,000 9,931,000
Diluted 10,012,000 10,214,000 10,373,000
============ ============ ============
</TABLE>
See accompanying notes to financial statements.
7
<PAGE> 7
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
COMMON SHARES (NOTE 6)
-------------------------- RETAINED TREASURY
SHARES AMOUNT EARNINGS SHARES
----------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
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)
Common Shares Repurchased At Cost -- -- -- (104,000)
Common Shares Issued For Purchases
Under Employee Benefit Plan (72,000) -- 235,000
Exercise of Stock Options 4,000 24,000 -- --
Net loss -- -- (1,464,000) --
----------- ----------- ----------- ----------
Balance at March 31, 1999 10,012,000 $13,052,000 $ 1,641,000 $ --
=========== =========== =========== ==========
</TABLE>
See accompanying notes to financial statements.
8
<PAGE> 8
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN CASH
YEARS ENDED MARCH 31,
-----------------------------------------
1999 1998 1997
----------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $(1,464,000) 797,000 5,035,000
Adjustments to reconcile net earnings (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 894,000 617,000 280,000
Loss on disposition of property and equipment 77,000 -- --
Compensation expense related
to option grants -- 7,000 --
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 304,000 (140,000) 543,000
Decrease (increase) in inventories (509,000) (1,070,000) (2,052,000)
Decrease (increase) in income taxes refundable (115,000) (45,000) (527,000)
Decrease (increase) in prepaid expenses (45,000) (77,000) (27,000)
Decrease (increase) in deferred income taxes (381,000) 292,000 --
Decrease (increase) in note receivable
from related party 58,000 (126,000) --
Decrease (increase) in other assets 6,000 (305,000) (942,000)
Decrease (decrease) in accounts payable (503,000) 386,000 (55,000)
Decrease (decrease) in accrued expenses 347,000 225,000 (17,000)
Decrease (decrease) in income taxes payable -- 103,000 (105,000)
----------- ---------- ----------
Net cash provided by (used in) operating activities (1,331,000) 664,000 2,133,000
----------- ---------- ----------
Cash flows from investing activities:
Decrease (increase) in marketable securities -- -- 1,029,000
Capital expenditures (194,000) (1,431,000) (2,912,000)
Dispositions of property and equipment -- -- 5,000
----------- ---------- ----------
Net cash (used in) investing activities (194,000) (1,431,000) (1,878,000)
----------- ---------- ----------
Cash flows from financing activities:
Exercise of stock options 24,000 156,000 216,000
Common shares purchased (104,000) (285,000) (183,000)
Common shares issued 163,000 186,000 224,000
Common shares tendered and retired -- -- (32,000)
----------- ---------- ----------
Net cash provided by financing activities 83,000 57,000 225,000
----------- ---------- ----------
Net increase (decrease) in cash (1,442,000) (710,000) 480,000
Cash beginning of year 1,579,000 2,289,000 1,809,000
----------- ---------- ----------
Cash end of year $ 137,000 1,579,000 2,289,000
=========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
income taxes $ -- 185,000 4,010,000
=========== ========== ==========
Supplemental schedule of noncash investing
and financing activities:
Common stock issued as payment of dividend $ -- -- 5,779,000
Tax benefit from exercise of non-qualified stock options -- 103,000 75,000
=========== ========== ==========
See accompanying notes to financial statements.
</TABLE>
9
<PAGE> 9
NOTES TO FINANCIAL
MARCH 31, 1999
(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, 1999 and 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 the straight-line
method 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. Reserves
for customer returns have not been established as historical experience has
been minor.
COMPREHENSIVE INCOME
The Financial Accounting Standards Board issued Statement No. 130, Reporting
Comprehensive Income ("SFAS 130"), in June, 1997. SFAS 130 establishes standards
for reporting and display of comprehensive income and its components in
financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. The Company adopted SFAS No. 130 on April 1, 1998.
Comprehensive income is the change in equity of a business enterprise during a
period from transactions and all other events and circumstances from nonowner
sources. Other comprehensive income includes foreign currency items, minimum
pension liability adjustments and unrealized gains and losses on certain
investments in debt and equity securities. The Company did not have components
of other comprehensive income during the periods ended March 31, 1999, 1998 and
1997. As a result, comprehensive income (loss) is the same as net earnings
(loss) for the periods ended March 31, 1999, 1998 and 1997.
EARNINGS PER COMMON SHARE
The Company accounts for net earnings per common share in accordance with the
Statement of Financial Accounting Standards No. 128. Following is a
reconciliation of the numerators and denominators used in the calculation of
basic and diluted earnings (loss) per common share for the years ended March
31, 1999, 1998 and 1997, respectively:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Basic earnings per share
Numerator - net earnings (loss) $(1,464,000) 797,000 5,035,000
Denominator - common
shares outstanding 10,012,000 9,958,000 9,931,000
----------- ----------- -----------
Basic earnings per share $ (.15) $ .08 $ .51
=========== =========== ===========
Diluted earnings (loss) per share
Numerator - net earnings (loss) $(1,464,000) 797,000 5,035,000
Denominator -
Common shares outstanding 10,012,000 9,958,000 9,931,000
Common stock options -- 256,000 442,000
----------- ----------- -----------
10,012,000 10,214,000 10,373,000
----------- ----------- -----------
Diluted earnings (loss) per share $ (.15) $ .08 $ .49
=========== =========== ===========
</TABLE>
Options to purchase 1,045,000 shares of common stock at prices ranging from
$1.50 to $12.54 per share were not included in the computation of diluted
earnings per share in 1999 because their inclusion would be anti-dilutive.
All of the share, per share and weighted average number of shares have been
retroactively 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 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 account-
10
<PAGE> 10
ed 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
1999. The Company's customers are affected by Medicare reimbursement policy as
approximately 80% of home oxygen patients are covered by Medicare and other
government programs.
STOCK OPTION PLAN
The Company accounts for its stock option plan in accordance with the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. The Company has also adopted
the pro forma disclosure provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, which
permits entities to provide pro forma net income and pro forma earnings per
share disclosures for employee stock option grants made in 1995 and subsequent
years as if the fair-value-based method defined in SFAS No. 123 had been
applied.
SEGMENT INFORMATION
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 the basis for
identifying reportable segments. FAS 131 is effective for financial statements
for periods beginning after December 15, 1997. The Company adopted FAS 131 in
the annual financial statements of the fiscal year ending March 31, 1999. The
Company operates in only one segment.
(2) INVENTORIES
At March 31, 1999 and 1998, inventories consisted of the following:
<TABLE>
<CAPTION>
1999 1998
---------- ---------
<S> <C> <C>
Finished goods $1,619,000 1,154,000
Work in process 1,278,000 1,117,000
Raw materials and supplies 4,745,000 4,862,000
---------- ----------
$7,642,000 7,133,000
========== ==========
</TABLE>
During the year ended March 31, 1999, the Company incurred inventory
write-downs totaling $734,000.
(3) INCOME TAXES
The provision (benefit) for income taxes for fiscal 1999, 1998 and 1997
consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ------- ---------
<S> <C> <C> <C>
Current:
Federal $(517,000) 137,000 2,609,000
State (45,000) 106,000 769,000
--------- ------- ---------
(562,000) 243,000 3,378,000
Deferred:
Federal (183,000) 274,000 (10,000)
State (198,000) 18,000 10,000
--------- ------- ---------
(381,000) 292,000 --
--------- ------- ---------
Total $(943,000) 535,000 3,378,000
========= ======= =========
</TABLE>
A reconciliation of the difference between the Company's provision (benefit)
for income taxes and the statutory income tax for the years ended March 31,
1999, 1998 and 1997, respectively, is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ------- ---------
<S> <C> <C> <C>
Statutory tax expense
(benefit) $(819,000) 453,000 2,860,000
State income tax, net (109,000) 82,000 514,000
Warranty and other -- -- 4,000
Tax Credits, Net (15,000) -- --
--------- ------- ---------
$(943,000) 535,000 3,378,000
========= ======= =========
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at March 31, 1999 and 1998 are presented as follows:
<TABLE>
<CAPTION>
1999 1998
--------- --------
<S> <C> <C>
State taxes $ -- 29,000
Bad debt reserves 38,000 36,000
Accrued expenses 193,000 57,000
Inventories 258,000 23,000
Net Operating Loss 79,000 --
Tax Credits 44,000 --
--------- -------
Total deferred tax assets 612,000 145,000
Deferred tax liabilities:
Depreciation (97,000) (81,000)
State Taxes (70,000) --
--------- -------
Net deferred tax assets $445,000 64,000
========= =======
</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 and
future projected 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%, and is due in April,
2012.
(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.
Accumulated amortization on the license fee amounted to $121,000 and $29,000 at
March 31, 1999 and 1998, respectively.
11
<PAGE> 11
(6) SHAREHOLDERS' EQUITY
In 1999, 1998 and 1997 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 charged or credited to shareholders' equity.
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, 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 5.67
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
Cancelled (30,000) (225,000) 7.39
Expired (226,000) (2,221,000) 9.88
Granted 349,000 1,532,000 4.38
Exercised (1,000) (8,000) 5.08
-------- ----------- -----
Outstanding - March 31, 1999 880,000 $ 4,886,000 5.55
======== =========== =====
Exercisable - March 31, 1999 529,000 $ 2,624,000 4.96
======== =========== =====
Non-qualified Options:
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
Granted 15,000 118,000 7.63
Exercised (3,000) (16,000) 5.18
-------- ----------- -----
Outstanding - March 31, 1999 165,000 $ 1,490,000 9.03
======== =========== =====
Exercisable - March 31, 1999 139,000 $ 1,182,000 8.50
======== =========== =====
</TABLE>
At March 31, 1999, information regarding outstanding option is summarized as
follows:
<TABLE>
<S> <C> <C>
Range of exercise prices $1.50-6.69 7.63-12.54
Number of outstanding 782,000 263,000
Weighted average
remaining life (yrs.) 7.4 8.0
Weighted average
exercise price $ 4.46 $ 10.38
Number exercisable 556,000 112,000
Weighted average
exercise price $ 4.57 $ 11.28
</TABLE>
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 (loss) in 1999, 1998 and 1997
would have been reduced (increased) by approximately ($415,000), $247,000 and
$214,000, respectively, and earnings (loss) per share would have been reduced
(increased) by ($.04), $.02 and $.09 per share in 1999, 1998 and 1997,
respectively. The weighted average fair value of options granted during 1999,
1998 and 1997 is estimated at $2.03, $5.41 and $2.83, respectively. The
disclosure of compensation cost under this pronouncement may not be
representative of the effects on net earnings (loss) for future years. The fair
value of options granted during each period was estimated using the
Black-Scholes option pricing model with the following assumptions.
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Risk-free interest rate 5.9% 5.9% 5.9%
Forfeiture rate 2.0% 2.0% 2.0%
Dividend yield .0 .0 .0
Volatility 63% 57% 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 and $96,000 of the plan contributions during 1998 and
1997, respectively. There was no contribution in 1999.
12
<PAGE> 12
(8) ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
1999 1998
-------- ---------
<S> <C> <C>
Accrued royalties $126,000 144,000
Deferred revenue -- 98,000
Product and business
liability insurance 63,000 41,000
Deferred rent 74,000 92,000
Accrued vacation 80,000 76,000
Retirement liability 271,000 --
Other 365,000 181,000
-------- --------
$979,000 632,000
======== ========
</TABLE>
At March 31, 1999, the Company had an obligation to pay its founder and former
Chief Executive Officer $75,000 per year in retirement pay for four years. The
retirement liability represents the net present value of this obligation.
(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>
2000 356,000
2001 344,000
2002 354,000
2003 368,000
2004 93,000
----------
TOTAL $1,515,000
==========
</TABLE>
Rent expense amounted to $442,000, $440,000, and $417,000 for the years ended
March 31, 1999, 1998 and 1997, respectively. Purchases pursuant to these
commitments amounted to $2,549,000 and $471,000 for the year ended March 31,
1999 and 1998, respectively.
At March 31, 1999, the Company had purchase commitments outstanding totaling
approximately $585,000.
At March 31, 1999, the Company had a revolving line of credit with its bank for
$1,500,000 which provides for interest at .5% above the prime rate. The line of
credit expires August 1, 1999, and there was no balance outstanding at March
31, 1999. Borrowings under the line are secured by receivables and inventory
and the Company is required to comply with certain covenants and restrictions.
At March 31, 1999, the Company was not in compliance with respect to the
requirements for tangible net worth and the amount of the loss for the year
ending March 31, 1999, but had received a waiver for these requirements from
the bank. The line was cancelled subsequent to March 31, 1999.
The Company is involved in certain legal actions resulting from the ordinary
course of business. The Company believes the ultimate outcome of the legal
actions will not have a material adverse impact on the Company's financial
position.
(10) GEOGRAPHIC INFORMATION
The Company has one reportable operating segment as defined in Note 1.
Geographic information regarding the Company's sales is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
----------- ---------- ----------
<S> <C> <C> <C>
United States $12,350,000 14,866,000 23,567,000
Germany 642,000 632,000 1,146,000
All other countries 1,072,000 1,095,000 1,448,000
----------- ---------- ----------
$14,064,000 16,593,000 26,161,000
=========== ========== ==========
</TABLE>
All long-lived assets are located in the United States.
Sales of OXYMATIC* conservers and OXYLITE* systems accounted for 72%, 82% and
90% of the Company's sales for the years ended March 31, 1999, 1998 and 1997,
respectively.
(11) VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
The following is the Company's schedule of activity in the valuation and
qualifying accounts and reserves for the years ended March 31, 1999, 1998 and
1997.
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
OF YEAR EXPENSES DEDUCTIONS OF YEAR
---------- ---------- ---------- -------
<S> <C> <C> <C> <C>
ALLOWABLE FOR
DOUBTFUL ACCOUNTS:
1997 $ 92,000 58,000 45,000 107,000
1998 107,000 37,000 39,000 105,000
1999 105,000 117,000 134,000 88,000
INVENTORY RESERVES:
1999 -0- 537,000 -0- 537,000
</TABLE>
(12) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents summarized unaudited quarterly financial data for
1999 and 1998:
<TABLE>
<CAPTION>
NET BASIC
GROSS EARNINGS EARNINGS (LOSS)
REVENUE PROFIT (LOSS) PER SHARE
---------- ----------- ---------- ---------------
<S> <C> <C> <C> <C>
1999
- ----
First Quarter $ 4,197,000 $ 1,940,000 $ 107,000 $ .01
Second Quarter 3,860,000 1,514,000 2,000 .00
Third Quarter 2,983,000 377,000 (894,000) (.09)
Fourth Quarter 3,024,000 465,000 (679,000) (.07)
----------- ----------- ----------- -----
Year $14,064,000 $ 4,296,000 $(1,464,000) $(.15)
=========== =========== =========== =====
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
=========== =========== =========== =====
</TABLE>
In the fourth quarter of 1999, the Company recorded an inventory write-down of
$298,000.
<PAGE> 13
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, 1999 and 1998 and the related statements of operations, shareholders'
equity and cash flows for each of the years in the three year period ended March
31, 1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on out 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, 1999 and 1998 and the results of its operations and its cash flows for
each of the years in the three year period ended March 31, 1999, in conformity
with generally accepted accounting principles.
/s/ KPMG LLP
Los Angeles, California
May 7, 1999
14
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Sales for the years ended March 31, 1999 and 1998, decreased $2,529,000 (15.2%)
and $9,568,000 (36.6%), respectively, from the prior year's periods. While there
have been price reductions in 1999 and 1998, the decrease in sales relates
primarily to decreases in domestic unit sales 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 12% and 10% of total sales for the
years ended March 31, 1999 and 1998, respectively. Currently, management expects
a decrease 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 US 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, such as the Company's products, which can extend the life of oxygen
supplies and reduce service calls by dealers, thereby providing improved
mobility for the patient and cost savings for dealers.
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 21% and 24% of the
Company's domestic sales for the years ended March 31, 1999 and 1998,
respectively. Margins on these sales may be somewhat lower due to quantity
pricing. In some instances consolidation 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 during the past two years have been
adversely 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, during the periods ended March 31, 1999 and 1998, sales
to national chain accounts as well as independent dealers have also been
impacted by increased competitive factors and concerns regarding the size of
potential cuts in Medicare home oxygen reimbursement which were being discussed
as part of the Federal budget process during the year ended March 31, 1998. This
process was finalized and a 25% cut in home oxygen reimbursement went into
effect January, 1998, with an additional 5% cut effective January 1, 1999. 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% and 5% cuts,
may continue to adversely affect the Company 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(2) Delivery System. The TOTAL 0(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 homecare dealers with 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(2) Systems in January, 1998, and realized
approximately $1,446,000 and $535,000 in sales during the years ended March 31,
1999 and 1998, respectively. Initial sales of the TOTAL 0(2) system have been
adversely affected by several factors, including the overall home oxygen market
climate as well as start-up manufacturing and related supplier quality issues.
The Company has taken a number of steps recently to resolve the manufacturing
and supplier issues. The sales potential for the new system is significant as
the average selling price is 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(2) system. For information
which may affect the outcome of forward looking statements made in this
paragraph see Outlook: Issues and Risks-New Product.
Cost of sales as a percent of net sales increased from 52.3% to 69.4% and from
43.4% to 52.3%, respectively, for the years ended
15
<PAGE> 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31, 1999 and 1998, as compared to the prior year's periods. Both periods
have been affected by higher fixed overhead costs associated with the Company's
move to new facilities in October, 1996, decreased sales volume and start-up
costs associated with the manufacture of the TOTAL 0(2) system. The period ended
March 31, 1999, was also affected by costs associated with the replacement of
two suppliers of components for the TOTAL 0(2) system and inventory write-downs
totaling $811,000. Management believes the gross margins should improve in the
future periods if TOTAL 0(2) system sales increase.
Selling, general and administrative expenditures increased slightly from
$6,042,000 to $6,119,000 and from $5,595,000 to $6,042,000 for the years ended
March 31, 1999 and 1998, respectively. The Company anticipates that recent cost
reduction efforts will reduce the annual rate of spending for these costs by
approximately $720,000. This reduction in costs should align staffing and
operating expenses more closely with current sales expectations, but will be
offset to some extent by commissions to be paid to the Company's new field sales
force of manufacturer's representatives. This field sales force has recently
been hired and trained, and now provides full coverage in the United States.
Historically, the Company has relied entirely on its internal sales personnel
and extensive marketing efforts to generate sales. The shift to a field sales
force will cause selling, general and administrative expenses to fluctuate more
closely with sales volume. Research and development expenses decreased by
$88,000 and $197,000 for the years ended March 31, 1999 and 1998, respectively,
as compared to the prior year's period. The decline relates to the completion of
development work on the TOTAL 0(2) system in 1998. Currently, management expects
research and development expenditures to total approximately $525,000 in the
fiscal year ended March 31, 2000, on projects to enhance and expand the
Company's product line. Interest income declined $123,000 for the year ended
March 31, 1999, as compared to the prior year due to the reduction in the
Company's cash balances.
FINANCIAL CONDITION
At March 31, 1999, the Company had cash totaling $137,000 or 1% of total assets,
as compared to $1,579,000 (9%) at March 31, 1998. Net working capital decreased
from $10,704,000 at March 31, 1998, to $10,164,000 at March 31, 1999. Accounts
receivable decreased $304,000 during the period ended March 31, 1999. 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 $509,000. This increase relates primarily to
raw materials purchased for the manufacture of the new TOTAL 0(2) 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 drops below target amounts, then
inventories in subsequent periods will increase more rapidly as inventory
balances are replenished.
Management believes funds derived from operations and income tax refunds should
be adequate to meet the Company's present cash requirements. The Company expects
capital expenditures during the next twelve months to be approximately $250,000.
On June 30, 1994, the Company announced that the Board of Directors had
authorized stock repurchases of its common shares in privately negotiated
transactions for a minimum of 10,000 shares. While the Company made no stock
repurchases during the year ended March 31, 1999, 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. The Company purchased
approximately 23,000, 38,000 and 15,000 shares at a cost of $104,000, $285,000
and $183,000 during the years ended March 31, 1999, 1998 and 1997 respectively.
The number of shares which may be purchased under these programs in the future
can not be predicted at this time. The Company has not adopted any programs
which provide for post employment retirement benefits, however, it has on
occasion provided such benefits to individual employees.
YEAR 2000
Management has initiated an enterprise-wide program to prepare the Company's
computer systems and applications for the year 2000 and to ensure Year 2000
compliance by its customers and suppliers. The Company's products do not contain
embedded chips that are date sensitive and thus they are not at risk for Year
2000 issues. The Company has completed the assessment of its internal computer
hardware and software and plans to have all systems Year 2000 compliant by June
30, 1999. The Company is in the assessment stage for its third party
relationships and plans to have this phase completed by June 30, 1999. At that
time, any third parties representing a material risk to the Company who do not
appear to be moving towards Year 2000 compliance should be identified and the
Company will attempt to secure back up suppliers wherever possible.
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 has not been and is not expected to be material. 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.
The Company is in the process of developing a contingency plan in
16
<PAGE> 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
the event of various problem scenarios. If the Company is unsuccessful or if
remediation efforts with key suppliers or customers are unsuccessful in dealing
with Year 2000 problems, there may be a material adverse impact on the Company's
results of operations and financial condition. The Company is unable to quantify
any potential adverse impact at this time.
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 healthcare market and the Company's ability to remain competitive
within this market sector.
NOW PRODUCT
The Company's future growth in the near term will depend in significant part
upon the commercial success of the TOTAL 0(2) Delivery System. The success of
this new product will depend upon the health care community's perception of the
system capabilities, clinical efficacy and benefit to patients, as well as
timely resolution of manufacturing and supplier issues. 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 0(2)
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 21% 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 priced products which do not
provide oxygen conserving capabilities comparable to the Company's products. No
assurance can be given that increased competition in the home oxygen market will
not continue to have an adverse affect 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 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 Company if any of these proposals is enacted.
Approximately 80% of home oxygen patients are covered by medicare and other
government programs. 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 has reduced Medicare spending. It cannot
yet 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 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.
17
<PAGE> 17
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 product liability insurance in an amount which it
believes to be customary in the industry, there is no assurance that this
insurance will be sufficient to cover the costs of defense or judgments which
might be entered against the Company. The type and frequency of these claims
could have an adverse impact on the Company's results of operations and
financial position.
AVAILABILITY OF THIRD PARTY COMPONENT PRODUCTS
The Company tests and packages its products in its own facility. Some of its
other manufacturing processes are conducted by other firms and the Company
expects to continue using outside firms for certain manufacturing processes for
the foreseeable future and is thus dependent on the reliability and quality of
parts supplied by these firms. The Company's agreements with its suppliers are
terminable at will or by notice. The Company believes that other suppliers would
be available in the event of termination of these arrangements. No assurance can
be given, however, that the Company will not suffer a material disruption in the
supply of its products.
ACCOUNTING STANDARDS
Accounting standards promulgated by the Financial Accounting Standards Board
change periodically. Changes in such standards may have an impact on the
Company's future 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.
18
<PAGE> 18
CORPORATE DATA
COMMON STOCK PRICE RANGE
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
high and low closing prices as furnished by the American Stock Exchange. Prices
have been adjusted to reflect a 2 for 1 split distributed October 15, 1993, and
a 3 for 2 split distributed on October 16, 1995.
<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
- ----------------------- ------- -----
<S> <C> <C>
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
June 30, 1998 8-3/16 5-1/2
September 30, 1998 6-1/8 2-3/8
December 31, 1998 3-7/8 1-7/16
March 31, 1999 2-1/4 1
</TABLE>
As of June 11, 1999, there were approximately 305 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:
Executive Vice President
Chad Therapeutics, Inc.
21622 Plummer Street
Chatsworth, CA 91311
19
<PAGE> 19
[BACK COVER]
<PAGE> 1
EXHIBIT 23.1
ACCOUNTANTS' 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 7,
1999, relating to the balance sheets of Chad Therapeutics, Inc. as of March 31,
1999 and 1998, and the related statements of operations, shareholders' equity,
and cash flows for each of the years in the three-year period ended March 31,
1999, which report appears in the March 31, 1999, annual report on Form 10-K of
Chad Therapeutics, Inc.
KPMG LLP
Los Angeles, California
June 21, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 137
<SECURITIES> 0
<RECEIVABLES> 2,165
<ALLOWANCES> 0
<INVENTORY> 7,642
<CURRENT-ASSETS> 11,370
<PP&E> 5,366
<DEPRECIATION> 2,086
<TOTAL-ASSETS> 15,899
<CURRENT-LIABILITIES> 1,206
<BONDS> 0
0
0
<COMMON> 13,052
<OTHER-SE> 1,641
<TOTAL-LIABILITY-AND-EQUITY> 15,899
<SALES> 14,064
<TOTAL-REVENUES> 0
<CGS> 9,768
<TOTAL-COSTS> 6,744
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,407)
<INCOME-TAX> (943)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,464)
<EPS-BASIC> (.15)
<EPS-DILUTED> (.15)
</TABLE>
