<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended: December 31, 1998
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)
(818) 882-0883
------------------------------------------
(Registrant's telephone number, including area code)
------------------------------------------
(Former Address)
(Former name, former address and former fiscal year, if changed since last
report.)
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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Shares 10,012,423
<PAGE> 2
CHAD THERAPEUTICS, INC.
Balance Sheets
December 31, 1998 and March 31, 1998
ASSETS
<TABLE>
<CAPTION>
December 31, March 31,
1998 1998
------------ ------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash $ 307,000 $ 1,579,000
Accounts receivable, less allowance for
doubtful accounts of $116,000 at
December 31, 1998 and $105,000 at
March 31, 1998 2,220,000 2,469,000
Inventories (Note 2) 8,760,000 7,133,000
Income taxes refundable 408,000 572,000
Prepaid expenses 219,000 249,000
Deferred income taxes 255,000 64,000
------------ ------------
Total current assets 12,169,000 12,066,000
Property and equipment, at cost 5,343,000 5,275,000
Less accumulated depreciation 1,889,000 1,310,000
------------ ------------
Net property and equipment 3,454,000 3,965,000
------------ ------------
Note receivable from related party 72,000 126,000
Other assets, net 1,214,000 1,279,000
------------ ------------
Total assets $ 16,909,000 $ 17,436,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 553,000 $ 730,000
Accrued expenses 986,000 632,000
------------ ------------
Total current liabilities 1,539,000 1,362,000
------------ ------------
Shareholders' equity:
Common shares, $.01 par value, authorized
40,000,000 shares; 10,012,000 and 10,008,000
shares issued and outstanding 13,054,000 13,100,000
Retained earnings 2,320,000 3,105,000
------------ ------------
15,374,000 16,205,000
Less treasury shares at cost, 1,000 and
19,000 shares (4,000) (131,000)
------------ ------------
Net shareholders' equity 15,370,000 16,074,000
------------ ------------
Total liabilities and shareholders' equity $ 16,909,000 $ 17,436,000
============ ============
</TABLE>
See accompanying notes to financial statements.
<PAGE> 3
CHAD THERAPEUTICS, INC.
Statements of Earnings
For the nine months ended December 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
---------------------------------
1998 1997
------------ ------------
<S> <C> <C>
Net sales $ 11,040,000 $ 13,052,000
Cost of sales 7,209,000 6,529,000
------------ ------------
Gross profit 3,831,000 6,523,000
Costs and expenses:
Selling, general and administrative 4,664,000 4,804,000
Research and development 467,000 499,000
------------ ------------
Total costs and expenses 5,131,000 5,303,000
------------ ------------
Operating income (loss) (1,300,000) 1,220,000
Other income - interest income 41,000 129,000
------------ ------------
Earnings (loss) before income taxes (1,259,000) 1,349,000
Income taxes (benefit) (474,000) 542,000
------------ ------------
Net earnings (loss) $ (785,000) $ 807,000
============ ============
Basic earnings (loss) per share $ (.08) $ .08
============ ============
Diluted earnings (loss) per share $ (.08) $ .08
============ ============
</TABLE>
See accompanying notes to financial statements.
<PAGE> 4
CHAD THERAPEUTICS, INC.
Statements of Earnings
For the three months ended December 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net sales $ 2,983,000 $ 3,234,000
Cost of sales 2,606,000 1,910,000
----------- -----------
Gross profit 377,000 1,324,000
Costs and expenses:
Selling, general and administrative 1,682,000 1,686,000
Research and development 145,000 176,000
----------- -----------
Total costs and expenses 1,827,000 1,862,000
----------- -----------
Operating income (loss) (1,450,000) (538,000)
Other income - interest income 10,000 60,000
----------- -----------
Earnings (loss) before income taxes (1,440,000) (478,000)
Income taxes (benefit) (546,000) (192,000)
----------- -----------
Net earnings (loss) $ (894,000) $ (286,000)
=========== ===========
Basic earnings (loss) per share $ (.09) $ (.03)
=========== ===========
Diluted earnings (loss) per share $ (.09) $ (.03)
=========== ===========
</TABLE>
See accompanying notes to financial statements.
<PAGE> 5
CHAD THERAPEUTICS, INC.
Statement of Shareholders' Equity
For the nine months ended December 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
Common Shares Retained Treasury
Shares Amount Earnings Shares
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance at
March 31, 1998 10,008,000 $ 13,100,000 $ 3,105,000 $ (131,000)
Exercise of stock options 4,000 24,000 -- --
Common Shares repurchased -- -- -- (79,000)
Common Shares issued for
purchases under employee
benefit plan -- (70,000) -- 206,000
Net loss -- -- (785,000) --
------------ ------------ ------------ ------------
Balance at
December 31, 1998 10,012,000 $ 13,054,000 $ 2,320,000 $ (4,000)
============ ============ ============ ============
</TABLE>
See accompanying notes to financial statements.
<PAGE> 6
CHAD THERAPEUTICS, INC.
Statements of Cash Flows
For the nine months ended December 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
-----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net earnings (loss) $ (785,000) $ 807,000
Adjustments to reconcile net earnings to net
cash provided by (used in) operating activities:
Depreciation and amortization 579,000 402,000
Loss on disposition of property & equipment 77,000 --
Compensation expense related to option grants -- 5,000
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 249,000 683,000
Decrease (increase) in inventories (1,627,000) (553,000)
Decrease (increase) in income taxes
refundable 164,000 358,000
Decrease (increase) in prepaid expenses 30,000 (348,000)
Decrease (increase) in deferred income taxes (191,000) --
Decrease (increase) in note receivable
from related party 54,000 (124,000)
Decrease (increase) in other assets 65,000 (325,000)
Increase (decrease) in accounts payable (177,000) 215,000
Increase (decrease) in accrued expenses 354,000 174,000
----------- -----------
Net cash provided by (used in)
operating activities (1,208,000) 1,294,000
----------- -----------
Cash flows from investing activities:
Capital expenditures (145,000) (1,088,000)
----------- -----------
Net cash used in investing
activities (145,000) (1,088,000)
----------- -----------
Cash flows from financing activities:
Exercise of stock options 24,000 31,000
Common Shares repurchased (79,000) (253,000)
Common Shares issued 136,000 141,000
----------- -----------
Net cash provided by (used in)
financing activities 81,000 (81,000)
----------- -----------
Net increase (decrease) in cash (1,272,000) 125,000
Cash beginning of period 1,579,000 2,289,000
----------- -----------
Cash end of period $ 307,000 $ 2,414,000
=========== ===========
</TABLE>
See accompanying notes to financial statements.
<PAGE> 7
CHAD THERAPEUTICS, INC.
December 31, 1998
(Unaudited)
1. Interim Reporting
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.
In the opinion of management, all adjustments necessary, which are of a
normal and recurring nature, to a fair statement of the results for the
interim periods presented have been made. The interim statements are
condensed and do not include some of the information necessary for a more
complete understanding of the financial data. Accordingly, your attention
is directed to the footnote disclosures found on pages 14, 15, 16 and 17 of
the March 31, 1998, Annual Report and particularly to Note 1 which includes
a summary of significant accounting policies.
2. Inventories
Inventories at December 31, 1998, are summarized as follows:
<TABLE>
<S> <C>
Finished goods $1,515,000
Work-in-process 1,172,000
Raw materials 6,073,000
----------
$8,760,000
==========
</TABLE>
3. Earnings Per Common Share
Following is a reconciliation of the numerators and denominators used in
the calculation of basic and diluted earnings per common shares:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31 December 31
------------------------------- -------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Basic earnings per share:
Numerator-net earnings (loss) $ (894,000) $ (286,000) $ (785,000) $ 807,000
Denominator-common shares
outstanding 10,012,000 9,955,000 10,011,000 9,952,000
------------ ------------ ------------ ------------
Basic earnings (loss) per
share $ (.09) $ (.03) $ (.08) $ .08
============ ============ ============ ============
Diluted earnings per share:
Numerator-net earnings (loss) $ (894,000) $ (286,000) $ (754,000) $ 807,000
Denominator:
Common shares outstanding 10,012,000 9,952,000 10,011,000 9,952,000
Common stock options -- -- -- 277,000
------------ ------------ ------------ ------------
10,012,000 9,955,000 10,011,000 10,229,000
------------ ------------ ------------ ------------
Diluted earnings (loss) per
share $ (.09) $ (.03) $ (.08) $ .08
============ ============ ============ ============
</TABLE>
<PAGE> 8
CHAD THERAPEUTICS, INC.
December 31, 1998
(Unaudited)
3. Earnings Per Common Share (cont'd)
Options to purchase 1,224,000 shares of common stock at prices ranging from
$1.68 to $13.471 per share were not included in the computation of diluted
earnings per share because their effect would have been anti-dilutive.
4. 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 three and nine month periods ended December 31, 1998 and
1997. As a result, comprehensive income is the same as the net income for
the three and nine month periods ended December 31, 1998 and 1997.
5. Income Taxes
Income taxes have been provided for at an effective combined Federal and
California rate of approximately 40% for all periods presented.
<PAGE> 9
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
Results of Operations
Sales for the three and nine months ended December 31, 1998, decreased $251,000
and $2,012,000 or 7.8% and 15.4%, respectively, from the prior year's periods.
There were no price changes during 1997. While there have been price reductions
in 1998, the decrease in sales relates primarily to decreases in domestic unit
sales in 1998 of OXYMATIC conservers and OXYLITE complete portable oxygen
systems which are being affected by the current marketing environment for home
oxygen therapy discussed below.
Sales to foreign distributors represented 13% and 11% of total sales for the
nine month periods ended December 31, 1998 and 1997, 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 25% of the
Company's domestic sales for the nine month periods ended December 31, 1998 and
1997, 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
<PAGE> 10
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
Results of Operations (cont'd)
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
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 December 31, 1998 and 1997, sales
to national chain accounts as well as independent dealers have also been
impacted by increased competitive factors and uncertainties regarding the size
of potential cuts in Medicare home oxygen reimbursement which were being
discussed as part of the Federal budget process. This process has now been
finalized and a 25% cut in home oxygen reimbursement went into effect January,
1998. The effects of managed care and concerns over the severity of
reimbursement cuts has, in many cases, resulted in the provision of systems to
patients that do not provide truly ambulatory oxygen. Management believes these
factors, including uncertainties as to how home care providers will respond to
the 25% cut, may continue to adversely affect the Company's revenues from sales
of oxygen conserving devices for the foreseeable future.
Management also believes future revenues may be positively affected by sales of
a new product, the TOTAL O(2)(TM) Delivery System. The TOTAL O(2) system
provides stationary oxygen for patients at home, portable oxygen including an
oxygen conserving device for ambulation and a safe and efficient mechanism for
filling portable oxygen cylinders. This should provide home care dealers with a
means to deal with the reimbursement cuts discussed above by reducing their
monthly cost of servicing patients while at the same time providing a higher
quality of service by maximizing ambulatory capability. The Company received
clearance in November, 1997, to sell the new product from the Food and Drug
Administration. The Company began shipping TOTAL O(2) systems in January, 1998,
and realized approximately $404,000 and $964,000 in sales during the three and
nine month periods ended December 31, 1998, respectively. 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
<PAGE> 11
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
Results of Operations (cont'd)
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 O(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 59.1% to 87.4% and from
50.0% to 65.3%, respectively, for the three and nine month periods ended
December 31, 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. In addition, the periods ended December 31,
1998, have been affected by decreased sales volume and start-up costs associated
with the manufacture of the TOTAL O(2) system. The periods ended December 31,
1998, were also affected by costs associated with the replacement of two
suppliers of components for the TOTAL O(2) system and inventory write-downs
totaling $513,000, of which $77,000 was charged to General and Administrative
expenses. Management believes the gross margins should remain at or decline
slightly from the nine month period ended December 31, 1998, in the future
periods as TOTAL O(2) system sales increase.
Selling, general and administrative expenditures decreased slightly from
$1,686,000 to $1,682,000 and from $4,804,000 to $4,664,000 for the three and
nine month periods ended December 31, 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 manufacturers representatives. This field
sales force is currently being hired and trained, with full coverage in the
United States expected by March 31, 1999. Research and development expenses
decreased by $32,000 for the nine months ended December 31, 1998, as compared to
the prior year's period. Currently, management expects research and development
expenditures to total approximately $600,000 in the fiscal year ended March 31,
1999, on projects to enhance and expand the Company's product line.
<PAGE> 12
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
Financial Condition
At December 31, 1998, the Company had cash totaling $307,000 or 2% 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 $10,661,000 at December 31,
1998. Accounts receivable decreased $249,000 during the period ended December
31, 1998. Future increases or decreases in accounts receivable will generally
coincide with sales volume fluctuations and the timing of shipments to foreign
customers. During the same period, inventories increased $1,627,000. This
increase relates primarily to raw materials purchased for the manufacture of the
new TOTAL O(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 drop
below target amounts, then inventories in subsequent periods will increase more
rapidly as inventory balances are replenished.
Management believes funds derived from operations and funds to be provided from
a line of credit with its bank on a short term basis should be adequate to meet
the Company's present cash requirements. The line of credit is for up to
$2,000,000 which funds the Company intends to use, as necessary, for expansion
of the TOTAL O(2) product line and for working capital purposes. 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 nine month period ended December 31, 1998, the Company
may make additional stock repurchases pursuant to the Board of Directors
authorization in the future. In addition, the Board has authorized the Company
to purchase shares of the Company's common stock in open market transactions.
The Company purchased approximately 18,000 and 35,000 shares at a cost of
$79,000 and $253,000 during the nine month periods ended December 31, 1998 and
1997, respectively. However, the number of shares which may be purchased under
these programs in the future can not be predicted at this time. The Company does
not provide post employment retirement benefits.
<PAGE> 13
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
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 March
31, 1999. The Company is in the assessment stage for its third party
relationships and plans to have this phase completed by March 31, 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 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 has not yet developed a contingency plan in the event of various
problem scenarios, but will assess the need to develop such a plan based on the
outcome of its survey of major customers and suppliers. 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 and financial condition. The Company is unable
to quantify any potential adverse impact at this time.
Newly Issued Accounting Standards
The Financial Accounting Standards Board issued Statement No. 130, "Reporting
Comprehensive Income" ("FAS 130", in June, 1997. FAS 130 establishes standards
for reporting and display of comprehensive income and its components in
financial statements. FAS 130 is effective for both interim and annual periods
beginning after December 15, 1997. The Company had adopted FAS 130 in the
quarter ended June 30, 1998. The adoption of FAS 130 did not have a material
impact on the Company's financial position or results of operations.
<PAGE> 14
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
Newly Issued Accounting Standards (cont'd)
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 custom ers. It replaces the "industry segment" concept of FAS No. 14,
"Financial Reporting for Segments of a Business Enterprise", with a "management
approach" concept as to basis for identifying reportable segments. FAS 131 is
effective for financial statements for periods beginning after December 15,
1997. The Company will adopt FAS 131 in the annual financial statements of the
fiscal year ending March 31, 1999. Management believes the adoption of FAS 131
will not have a material impact on the Company's financial position or results
of operations.
Outlook: Issues & Risks
This quarterly report contains forward-looking statements which reflect the
Company's current views with respect to future events and financial performance.
These forward- looking statements are subject to certain risks and uncertainties
which may cause actual operating results to differ materially from currently
anticipated results. Among the factors that could cause actual results to differ
materially are the following:
Dependence Upon a Single Product Line
Although the Company currently markets a number of products, these products
comprise a single product line for patients requiring supplementary oxygen. The
Company's future performance is thus dependent upon developments affecting this
segment of the health care market and the Company's ability to remain
competitive within this market sector.
New Product
The Company's future growth in the near term will depend in significant part
upon the commercial success of the TOTAL O2 Delivery System. The success of this
new product will depend upon the health care community's perception of the
system's capabilities, clinical efficacy and benefit to
<PAGE> 15
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
Consolidation of Home Care Industry (cont'd)
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 O(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's competitors have substantially
greater funds and facilities to pursue research and development of new products
and technologies for oxygen therapy.
<PAGE> 16
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
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.
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.
Products Liability
The nature of the Company's business subjects it to potential legal actions
asserting that the Company is liable for damages for product liability claims.
Although the Company maintains products liability insurance in an amount which
it believes to be customary in the industry, there is no assurance that this
insurance will be sufficient to cover the costs of defense or judgments which
might be entered against the Company. The type and frequency of these claims
could have an adverse impact on the Company's results of operations and
financial position.
Availability of Third Party Component Products
The Company tests and packages its products in its own facility. Some of its
other manufacturing processes are conducted by other firms and the Company
expects to continue using outside firms for certain manufacturing
<PAGE> 17
CHAD THERAPEUTICS, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
December 31, 1998
Availability of Third Party Component Products (cont'd)
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.
<PAGE> 18
SIGNATURES
Pursuant to the requirements 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.
CHAD THERAPEUTICS, INC.
-----------------------------------
(Registrant)
Date 2/10/99 /S/ Thomas E. Jones
-----------------------------------
Thomas E. Jones
Chief Executive Officer
Date 2/10/99 /S/ Earl L. Yager
-----------------------------------
Earl L. Yager
Executive Vice President,
Chief Financial Officer and
Secretary
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