Chad Therapeutics, Inc.
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarterly Period Ended: June 30, 2007
Or
o Transition Report Pursuant to Section 13 or 15(d) of
the
Securities Exchange Act of 1934
Commission file number: 1-12214
CHAD THERAPEUTICS, INC.
(Exact name of registrant as specified in its charter)
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California
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95-3792700 |
(State of other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
21622 Plummer Street, Chatsworth, CA 91311
(Address of principal executive offices) (Zip Code)
(818) 882-0883
(Registrants 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 þ No o
Indicate by check whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule
12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act).
Yes o No þ
As of June 30,2007, the registrant had 10,180,000 shares of its common stock outstanding.
TABLE OF CONTENTS
CHAD THERAPEUTICS, INC.
Condensed Balance Sheets
June 30, 2007 and March 31, 2007
(Unaudited)
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June 30, |
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March 31, |
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2007 |
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2007 |
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ASSETS |
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Current assets: |
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Cash |
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$ |
261,000 |
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$ |
375,000 |
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Accounts receivable, less allowance for
doubtful accounts of $37,000 at
June 30, 2007, and $38,000 at
March 31, 2007 |
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1,482,000 |
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2,376,000 |
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Income taxes refundable |
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290,000 |
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291,000 |
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Inventories (Note 5) |
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5,870,000 |
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6,557,000 |
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Prepaid expenses and other assets |
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290,000 |
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321,000 |
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Total current assets |
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8,193,000 |
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9,920,000 |
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Property and equipment, at cost |
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6,206,000 |
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6,186,000 |
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Less accumulated depreciation |
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5,578,000 |
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5,501,000 |
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Net property and equipment |
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628,000 |
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685,000 |
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Intangible assets, net |
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1,073,000 |
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1,107,000 |
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Other assets |
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35,000 |
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36,000 |
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Total assets |
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$ |
9,929,000 |
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$ |
11,748,000 |
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LIABILITIES AND SHAREHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
731,000 |
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$ |
1,282,000 |
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Accrued expenses |
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1,390,000 |
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1,372,000 |
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Total current liabilities |
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2,121,000 |
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2,654,000 |
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Shareholders equity: |
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Common shares, $.01 par value, authorized
40,000,000 shares; 10,180,000 and 10,158,000
shares issued and outstanding |
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13,530,000 |
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13,526,000 |
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Accumulated deficit |
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(5,722,000 |
) |
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(4,432,000 |
) |
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Total shareholders equity |
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7,808,000 |
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9,094,000 |
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Total liabilities and shareholders equity |
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$ |
9,929,000 |
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$ |
11,748,000 |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the three months ended June 30, 2007 and 2006
(Unaudited)
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Three Months Ended |
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June 30, |
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2007 |
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2006 |
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Net sales |
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$ |
3,973,000 |
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$ |
5,476,000 |
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Cost of sales |
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3,178,000 |
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3,662,000 |
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Gross profit |
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795,000 |
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1,814,000 |
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Costs and expenses: |
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Selling, general, and administrative |
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1,549,000 |
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1,702,000 |
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Research and development |
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462,000 |
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335,000 |
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Total costs and expenses |
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2,011,000 |
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2,037,000 |
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Operating loss |
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(1,216,000 |
) |
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(223,000 |
) |
Interest (income) expense |
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22,000 |
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(14,000 |
) |
Other (income) expense |
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48,000 |
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(9,000 |
) |
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Loss before income taxes |
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(1,286,000 |
) |
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(200,000 |
) |
Income tax expense (benefit) |
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4,000 |
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(84,000 |
) |
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Net loss |
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$ |
(1,290,000 |
) |
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$ |
(116,000 |
) |
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Basic loss per share |
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$ |
(0.13 |
) |
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$ |
(0.01 |
) |
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Diluted loss per share |
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$ |
(0.13 |
) |
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$ |
(0.01 |
) |
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Weighted shares outstanding: |
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Basic |
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10,180,000 |
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10,169,000 |
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Diluted |
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10,180,000 |
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10,169,000 |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
Condensed Statement of Shareholders Equity
For the three months ended June 30, 2007
(Unaudited)
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Common Shares |
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Accumulated |
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Shares |
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Amount |
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Deficit |
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Balance as of March 31, 2007 |
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10,180,000 |
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$ |
13,526,000 |
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$ |
(4,432,000 |
) |
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Stock-based compensation options |
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4,000 |
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Net loss |
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(1,290,000 |
) |
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Balance at June 30, 2007 |
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10,180,000 |
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13,530,000 |
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$ |
(5,722,000 |
) |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
Condensed Statement of Cash Flows
For the three months ended June 30, 2007 and 2006
(Unaudited)
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Three Months Ended |
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June 30, |
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2007 |
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2006 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(1,290,000 |
) |
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$ |
(116,000 |
) |
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities: |
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Depreciation and amortization of property and equipment |
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77,000 |
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98,000 |
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Amortization of intangibles |
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59,000 |
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11,000 |
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Provision for losses on receivables |
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(1,000 |
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Decrease (increase) in deferred income taxes |
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(9,000 |
) |
Stock-based compensation |
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4,000 |
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20,000 |
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Changes in assets and liabilities: |
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Decrease (increase) in accounts receivable |
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895,000 |
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36,000 |
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Decrease (increase) in inventories |
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687,000 |
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124,000 |
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Decrease (increase) in income taxes refundable |
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1,000 |
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93,000 |
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Decrease (increase) in prepaid expenses and other assets |
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32,000 |
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35,000 |
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Increase (decrease) in accounts payable |
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(551,000 |
) |
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487,000 |
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Increase (decrease) in accrued expenses |
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18,000 |
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118,000 |
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Net cash (used in) provided by operating activities |
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(69,000 |
) |
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897,000 |
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Cash flows from investing activities: |
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Additions to intangible assets |
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(25,000 |
) |
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(77,000 |
) |
Capital expenditures |
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(20,000 |
) |
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(49,000 |
) |
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Net cash (used in) provided by investing activities |
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(45,000 |
) |
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(126,000 |
) |
Cash flows from financing activities: |
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Other long-term liabilities |
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(2,000 |
) |
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Net cash (used in) provided by financing activities |
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(2,000 |
) |
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Net increase in cash |
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(114,000 |
) |
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769,000 |
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Cash beginning of period |
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375,000 |
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935,000 |
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Cash end of period |
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$ |
261,000 |
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$ |
1,704,000 |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. |
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Interim Reporting |
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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. |
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In the opinion of management, all adjustments necessary, which are of a normal and recurring
nature, for a fair presentation of the results for the interim periods presented, have been
made. The results for the three-month period ended June 30, 2007, are not necessarily
indicative of the results expected for the year ended March 31, 2008. 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 in the March 31, 2007, Annual Report and particularly to Note 1 which includes
a summary of significant accounting policies. |
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2. |
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Revenue Recognition |
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Revenue from product sales is recognized upon shipment of merchandise when title and risk of
loss transfers to the customer and the earnings process is complete. Products are shipped FOB
shipping point and title to the products transfers to the purchaser upon shipment. Under a
sales-type lease agreement, revenue is recognized at the time of the shipment with interest
income recognized over the life of the lease. Shipping charges billed to customers are
included in net sales. Allowances for customer returns have not been established, as
historically customer return experience has been minor. Costs paid to shipping companies are
recorded as a cost of sales. |
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3. |
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Major Customers |
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Three Months Ended |
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June 30, |
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2007 |
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2006 |
Customer A** |
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47.7 |
% |
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36.6 |
% |
Customer B |
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* |
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12.8 |
% |
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* |
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Indicates sales less than 10% of the Companys net sales |
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** |
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Indicates national chain customer |
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The Companys customers are affected by Medicare reimbursement policy as
approximately 80% of home oxygen patients are covered by Medicare and other government
programs. |
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4. |
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Concentration of Credit Risk |
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At times the Company maintains balances of cash that exceed $100,000 per account, the maximum
insured by the Federal Deposit Insurance Corporation. Further, the Company maintains a portion
of its cash funds in an interest bearing, uninsured account. The Companys right to the cash
is subject to the risk that the financial
institution will not pay when cash is requested. The potential loss is the amount
in |
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any one
account over $100,000 and/or all funds in the interest bearing account. At June 30, 2007, the
amount at risk was approximately $247,000. |
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The significant outstanding accounts receivable balances in 2007 were as follows: |
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June 30 |
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March 31 |
Customer A** |
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33.8 |
% |
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41.0 |
% |
Customer B** |
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14.4 |
% |
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* |
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* |
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Indicates receivables balance less than 10% of the Companys net accounts receivable balance. |
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** |
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Indicates national chain customer. |
5. |
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Inventories |
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Inventories in 2007 are summarized as follows: |
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June 30 |
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March 31 |
|
Finished goods |
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$ |
1,475,000 |
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$ |
1,841,000 |
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Work-in-process |
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|
2,006,000 |
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2,240,000 |
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Raw materials |
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2,389,000 |
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2,476,000 |
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$ |
5,870,000 |
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$ |
6,557,000 |
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6. |
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Leasing Arrangements |
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In the second quarter of fiscal year 2006, the Company entered into a capital lease agreement
for certain plant equipment totaling $14,000, with annual lease payments of $7,000, a fixed
interest rate of 7% and a purchase option at lease end in August 2007. The capital lease
obligation of $2,000 is included in accounts payable. Amortization of plant equipment under
capital leases is included in depreciation expense. |
7. |
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Earnings (Loss) Per Common Share |
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|
Following is a reconciliation of the numerators and denominators used in the calculation of
basic and diluted loss per common share: |
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Three Months Ended |
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|
June 30, |
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2007 |
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2006 |
|
Basic earnings (loss) per share: |
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|
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Numerator-net earnings (loss) |
|
$ |
(1,290,000 |
) |
|
$ |
(116,000 |
) |
Denominator-weighted average
common shares outstanding |
|
|
10,180,000 |
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|
10,169,000 |
|
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|
|
|
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|
|
|
|
|
Basic earnings (loss) per share |
|
$ |
(0.13 |
) |
|
$ |
(0.01 |
) |
|
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|
Diluted earnings (loss) per share: |
|
|
|
|
|
|
|
|
Numerator-net earnings (loss) |
|
$ |
(1,290,000 |
) |
|
$ |
(116,000 |
) |
Denominator-weighted average
common shares outstanding |
|
|
10,180,000 |
|
|
|
10,169,000 |
|
Diluted effect of common stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,180,000 |
|
|
|
10,169,000 |
|
|
|
|
|
|
|
|
Options to purchase 902,000 shares of common stock at prices ranging from $0.50 to $7.62
per share and 941,000 shares of common stock at prices ranging from $0.50 to $11.50 were not
included in the computation of diluted earnings per share for the three-month periods ended June
30, 2007 and 2006, respectively, because their effect would have been anti-dilutive.
8. |
|
Income Tax Expense |
|
|
|
Based on managements earnings projections for the fiscal year ended 2008, the Company has
forecasted an effective tax rate of 35 percent. The Company has Federal net operating loss
carryforwards of $1,459,000 expiring in 2027 and California net operating loss carryforwards of
$3,442,000 expiring in 2013. In assessing the realizability of deferred tax assets, management
considered whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. At June 30, 2007, the Companys deferred tax assets are fully
offset by a valuation allowance. |
9. |
|
Geographic Information |
|
|
|
The Company has one reportable operating segment. Geographic information regarding the
Companys net sales is as follows: |
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
June 30, |
|
|
|
2007 |
|
|
2006 |
|
United States |
|
$ |
3,579,000 |
|
|
$ |
4,354,000 |
|
Canada |
|
|
35,000 |
|
|
|
54,000 |
|
Japan |
|
|
58,000 |
|
|
|
126,000 |
|
Europe |
|
|
143,000 |
|
|
|
854,000 |
|
All other countries |
|
|
158,000 |
|
|
|
88,000 |
|
|
|
|
|
|
|
|
|
|
$ |
3,973,000 |
|
|
$ |
5,476,000 |
|
|
|
|
|
|
|
|
All long-lived assets are located in the United States.
Sales of OXYMATIC®, LOTUS and CYPRESS OXYPneumatic® conservers and SAGE Therapeutic devices
accounted for 70% of the Companys sales for the three-month periods ended June 30, 2007 and
2006, respectively.
On April 1, 2006, the Company adopted Statement of Financial Accounting Standards 123R,
Share-Based Payment, which revised SFAS 123, Accounting for Stock-Based Compensation. The
Company adopted FAS 123R using the modified prospective transition method. Previously, the
Company had followed APB 25, accounting for employee stock options at intrinsic value.
Accordingly, during the three-month periods ended June 30, 2007, the Company recorded
stock-based compensation expense for awards granted prior to, but not yet vested, as of April 1,
2006, as if the fair value method required for pro forma disclosure under FAS 123 were in effect
for expense recognition purposes, adjusted for estimated forfeitures. For stock-based awards
granted after April 1, 2006, the Company will recognize compensation expense based on the
estimated grant date fair value method using the Black-Scholes valuation model. For these
awards, the Company will recognize compensation expense using a straight-line method. As FAS
123R requires that stock based compensation expense be based on awards that are ultimately
expected to vest, stock-based compensation for the three-month period ended June 30, 2007, has
been reduced for estimated forfeitures. For the three-month periods ended June 30, 2007 and
2006, stock-based compensation expense of $4,000 and $10,000 respectively , was recorded to
selling, general, and administrative expenses, all of which was due to FAS 123R option expense.
Due to the prospective adoption of SFAS No. 123R, results for prior period have not been
restated.
The Company has an equity incentive plan (the Plan) for key employees as defined under Section
422(A) of the Internal Revenue Code. The Plan provides that 750,000 common shares be reserved
for issuance under the Plan, which expires on September 8, 2014, of which approximately 720,000
were available for future grant at June 30, 2007. In addition, the Plan provides that
non-qualified options can be granted to
directors and independent contractors of the Company.
Stock options are granted with
an exercise price equal to the market value of a share of the Companys stock on the date of the
grant. Historically, grants to non-employee directors have vested over two years, while the
majority of grants to employees have vested over two to five years of continuous service.
The fair value of each stock option award is estimated on the date of the grant using the
Black-Scholes option valuation model. Expected volatility is based on the historical volatility
of the Companys stock. No expected dividend yield is used since the Company has not
historically declared or paid dividends and no dividends are expected in the foreseeable future.
The risk-free interest rate is based on the U.S. treasury yield curve on the grant date for the
expected term of the option. The Company did not grant any stock options during the three
months ended June 30, 2007 and 2006, respectively. A summary of stock option activity as of and
for the three-months ended June 30, 2007, is presented below:
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|
|
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|
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|
|
Remaining |
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|
|
|
|
|
|
Exercise |
|
|
Contractual |
|
|
|
|
|
|
|
Price Per |
|
|
Term |
|
|
|
Shares |
|
|
Share |
|
|
(in years) |
|
|
|
|
Outstanding at March 31, 2007 |
|
|
904,000 |
|
|
$ |
2.09 |
|
|
|
|
|
Granted |
|
|
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|
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|
|
|
|
|
|
Exercised |
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|
|
|
|
|
|
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|
|
|
|
Forfeited or expired |
|
|
2,000 |
|
|
|
4.25 |
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2007 |
|
|
902,000 |
|
|
$ |
2.09 |
|
|
|
3.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2007: |
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable |
|
|
890,000 |
|
|
$ |
2.13 |
|
|
|
3.8 |
|
Vested and expected to vest |
|
|
900,000 |
|
|
$ |
2.13 |
|
|
|
3.8 |
|
|
|
|
|
|
No options were granted or exercised during the first three months of fiscal year 2007 or
2006. |
|
|
|
The aggregate intrinsic value is calculated as the difference between the exercise price of the
underlying awards and the quoted price of the Companys common stock at June 30, 2007 for the
options that were in-the-money June 30, 2007. As of June 30, 2007, there was approximately
$10,000 of unrecognized compensation cost related to unvested stock-based compensation
arrangements granted under the Plan. That cost is expected to be recognized over a
weighted-average period of 9 months. |
|
11. |
|
Commitments |
|
|
|
The Company is currently leasing its administrative and plant facilities and certain office
equipment under noncancelable operating leases that expire through June 2008. |
|
|
|
The Company has minimum annual royalty requirements pursuant to the terms of license agreements
related to certain products in the amount of $515,000. License agreements with minimum annual
royalty requirements are in place through fiscal year 2016. |
Employee obligations consist of an employment agreement (the Employment Agreement) with
Thomas E. Jones, Chairman of the Board of Directors. The Employment Agreement does not have a
specific term and provides for a base salary of $160,000 per year, which is subject to annual
review by the Board of Directors. The Employment Agreement may be terminated at any time by
the Company, with or without cause, and may be terminated by Mr. Jones upon 90 days notice.
If Mr. Jones resigns or is terminated for cause (as defined in the Employment Agreement), he is
entitled to receive only his base salary and accrued vacation through the effective date of his
resignation or termination. If Mr. Jones is terminated without cause, he is entitled to
receive a severance benefit in accordance with the Companys Severance and Change of Control
Plan, or if not applicable, a severance benefit equal to 200% of his salary and incentive bonus
for the prior fiscal year. In estimating its contractual obligation, the Company has assumed
that Mr. Jones will voluntarily retire at the end of the year he turns 65 and that no severance
benefit will be payable. This date may not represent the actual date the Companys payment
obligations under the Employment Agreement are extinguished.
In March 2007, the Company entered into a one-year factoring arrangement that provided for the
sale of up to $1,500,000 of the Companys accounts receivable. Assignments under the
agreement incurred interest at the banks prime rate plus two percent (2%) to three percent
(3%) depending on the total accounts receivable balance. The Company had a minimum monthly
interest payment of $6,000 beginning April 2007. The Company voluntarily terminated the
factoring agreement on July 30, 2007.
On July 30, 2007, the Company entered into a financing transaction with Calliope Capital
Corporation , a Delaware corporation (the Investor) pursuant to which the Company issued to
the Investor a $750,000 convertible term note (Convertible Note) and a $2,750,000 revolving
credit line (Credit Line), all secured by the Companys assets. The Convertible Note is
payable in equal installments over 36 months and bears interest at prime plus 2%, and the
Credit Line bears interest at prime plus 1.5%. A portion of the financing was used to pay all
outstanding obligations on the Companys factoring arrangement.
The Company is involved in certain legal actions 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 Companys financial statements as a whole.
12. |
|
Use of Estimates |
|
|
|
The preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues, and expenses, and the disclosure of contingent assets
and liabilities at the date of the financial statements. Actual results may differ from those
estimates. |
|
13. |
|
Accounting Standards |
|
|
|
In June 2006, the Financial Accounting Standards Board ratified EITF Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should be Presented in the
Income Statement. The EITF provides guidance on the |
|
|
proper presentation of tax assessed by a governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer and requires disclosure of the
Companys accounting policy decision. The consensus becomes effective for periods beginning
after December 15, 2006. The implementation of this interpretation did not have a significant
impact on the Companys financial statements. |
|
|
|
In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes. Interpretation No. 48 prescribes a recognition
threshold and measurement attribute for financial statement recognition and measurement of a
tax position taken, or expected to be taken, in a tax return. The Interpretation also provides
guidance on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. This Interpretation is effective for fiscal years
beginning after December 15, 2006. The implementation of this interpretation did not have a
significant impact on the Companys financial statements. |
|
|
|
In September 2006, the Financial Accounting Standards Board issued Staff Accounting Bulletin
No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements. SAB 108 requires registrants to quantify misstatements
using both the balance sheet and income-statement approaches and to evaluate whether either
approach results in quantifying an error that is material in light of relevant quantitative and
qualitative factors. The requirements are effective for annual financial statements covering
the first fiscal year ending after November 15, 2006. The implementation of this interpretation
did not have a significant impact on the Companys financial statements. |
|
|
|
In September 2006, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 157 Share-Based Payment. SFAS 157 establishes a single
authoritative definition of fair value, sets out a framework for measuring fair value, and
requires additional disclosures about fair-value measurements. SFAS 157 applies only to
fair-value measurements that are already required or permitted by other accounting standards.
The Statement is effective for fair-value measures already required or permitted by other
standards for financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The Company is evaluating the impact of this
interpretation and does not anticipate a significant impact to its financial statements upon
implementation. |
|
|
|
In September 2006, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 158 Employers Account for Defined Benefit Pension and Other
Post-retirement Plans. SFAS 158 requires employers to recognize on their balance sheets the
funded status of pension and other post-retirement benefit plans as of June 30, 2007, for the
calendar-year public companies. SFAS 158 will also require fiscal-year-end measurements of
plan assets and benefit obligations, eliminating the use of earlier measurement dates currently
permissible. The Company does not have a defined benefit pension plan, nor does it have any
other post-retirement plans. The implementation of this interpretation did not have a
significant impact on the Companys financial statements. |
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement
Certain statements in this report, including statements regarding our strategy, financial
performance, and revenue sources, are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended, and are subject to the safe
harbors created by those sections. These forward-looking statements are based on our current
expectations, estimates and projections about our industry, managements beliefs, and certain
assumptions made by us. Such statements are not guarantees of future performance and are subject to
certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual
results could differ materially and adversely from those expressed in any forward-looking
statements as a result of various factors. The section entitled Risk Factors set forth in this
Form 10-Q and similar discussions in filings with the Securities and Exchange Commission made from
time to time, including other quarterly reports on Form 10-Q, our Annual Reports on Form 10-K, and
in our other SEC filings, discuss some of the important risk factors that may affect our business,
results of operations, and financial condition.
The following discussion should be read in conjunction with our condensed financial statements and
notes thereto.
Overview
CHAD Therapeutics, Inc. (the Company) develops, assembles, and markets medical devices that
furnish supplementary oxygen to home health care patients. The Company was a pioneer in developing
oxygen conserving devices that enhance the quality of life for patients by increasing their
mobility and, at the same time, lower operating costs by achieving significant savings in the
amount of oxygen actually required to properly oxygenate patients. The market for oxygen
conserving devices has been, and continues to be, significantly affected by increased competition,
consolidation among home oxygen dealers, and revisions (and proposed revisions) in governmental
reimbursement policies. All of these factors, as described more fully below, have contributed to a
more difficult market for the Companys products.
The procedures for reimbursement by Medicare for home oxygen services provide a prospective flat
fee monthly payment based solely on the patients prescribed oxygen requirement. Beginning January
1, 2006, the reimbursement procedures were modified to provide that title for the equipment being
used by a patient transfers to the patient after 36 months. Under this system, inexpensive
concentrators have grown in popularity because of low cost and less frequent servicing
requirements. At the same time, oxygen conserving devices, such as the Companys products, have
also grown in popularity due to their ability to extend the life of oxygen supplies and reduce
service calls by dealers, thereby providing improved mobility for the patient and cost savings for
dealers. However, the uncertainties created by the new reimbursement procedures have adversely
affected the market for our products by causing many home health care dealers to delay
product purchases as they seek to assess the impact of the new procedures and proposed revisions.
On January 1, 2007, rates that include a new reimbursement category for transfilling systems like
the Companys TOTAL O2® Delivery System became effective. These new rates may ultimately have a
positive impact on the market for these types of devices. However, in 2003 Congress enacted the
Medicare Improvement and Modernization Act, which mandates that the monthly fees that homecare
providers receive for servicing oxygen patients will be subject to competitive bidding. The
process is scheduled to be implemented in ten major markets in August 2007. Continuing concern
among home care providers about the potential impact of these changes in reimbursement may affect
demand for the Companys products.
In addition, other changes in the health care delivery system, including the increase in the
acceptance and utilization of managed care, have stimulated a significant consolidation among home
care providers. Major national and regional home medical equipment chains have continued to expand
their distribution networks through the acquisition of independent dealers in strategic areas.
Margins on sales to national chains are generally lower due to quantity pricing and management
anticipates continued downward pressure on its average selling price. Four major national chains
accounted for approximately 56% and 43% of the Companys net sales for the three-month periods
ended June 30, 2007 and 2006, respectively. One chain accounted for 48% and 37% of net sales for
the three-month periods ended June 30, 2007 and 2006, respectively. This increased dependence on a
limited number of large customers may result in greater volatility and unpredictability of future
operating results as changes in the purchasing decisions by one or more major customers can have a
material effect upon our financial statements.
The Company believes that price competition and continuing industry consolidation will continue to
affect the marketplace for the foreseeable future. To address the competitive and unpredictable
nature of the oxygen conserver marketplace, the Company is pursuing the following strategy:
|
|
Development of additional oxygen conserver with a view to diversifying our product line in
order to offer customers a range of oxygen conservation choices. |
Over the past several years, the Company has introduced several additional models of
electronic conservers, pneumatic conservers, and the SAGE Oxygen Therapeutic Device. These
products expand the breadth of the Companys product line and offer additional features to
enhance their competitiveness in the marketplace. For example, the SAGE device senses a
patients movements and automatically adjusts the rate of oxygen delivery in order to
reduce the risk of desaturation as activity increases.
|
|
An effort to expand the Companys product offerings in order to reduce its dependence upon
the oxygen conserver sector. |
The Company has invested in the development of diagnostic and therapeutic devices for the
high-growth sleep disorder market. The first of these products are currently undergoing
testing and finalization of product design. While reports to date have been encouraging,
the Company cannot predict at this time when it will
commercially introduce such products, nor can it estimate the level of success it might
achieve in selling products for the sleep market. In addition to the sleep products, the
Company is considering other opportunities that might expand the product lines it offers
for the home health care market.
|
|
A continued promotional and educational campaign with respect to the benefits of the TOTAL
O2 system. |
The Company believes that the changing reimbursement environment should benefit the home
fill systems because of the opportunity for significant cost savings presented by such
systems. While the TOTAL O2 system was first introduced in 1998, sales were adversely
affected by several factors, including home care providers reluctance to invest in the
higher cost of the TOTAL O2 system to achieve lower monthly operating costs. Continuing
pressure on reimbursement rates and the establishment of a separate reimbursement category
for trans-fill systems may represent an emerging opportunity to promote the benefits of the
TOTAL O2 system.
|
|
Continuing efforts to reduce manufacturing costs. |
Recognizing the likelihood of continued pricing pressure for supplemental oxygen equipment,
the Company is continuing its efforts to reduce its manufacturing costs. These efforts
include implementation of internal practices intended to lower such costs, as well as the
exploration of opportunities to out-source certain components and processes.
While management believes the current growth strategy should enhance the Companys competitive
position and future operating performance, continuing price pressure on our conservers and concerns
about reimbursement changes have depressed operating results for the first three months of fiscal
2008. In addition, the Companys increased dependence on a limited number of large customers has
increased the volatility of our operating results. Management of the Company will continually
monitor these trends and will attempt to remain flexible in order to adjust to possible future
changes in the market for respiratory care devices. For information that may affect the outcome of
forward-looking statements in this Overview regarding the Companys business strategy and its
introduction of new products, see Part II of this report, Item 1A Risk Factors.
Results of Operations
Net sales for the three-month period ended June 30, 2007, decreased by $1,501,000 (27.4%) as
compared to the same period in the prior year. The primary reason for the decrease in sales for
the three-month period ended June 30, 2007, was price reductions on domestic conservers, as well as
decreases in TOTAL O2 sales and sales to foreign distributors. Domestic unit sales of conservers
and therapeutic devices for the three-month period ended June 30, 2007, decreased 4.7% as compared
to the same period in the prior year. However, domestic revenues from conserver and therapeutic
device sales decreased by 8.8% for the three-month period ended June 30, 2007 as compared to prior
year. As noted above, management expects continued downward pressure on its average selling price.
In addition, future operating results may be increasingly dependent upon purchasing decisions of a
limited number of large customers.
Revenues from TOTAL O2 sales decreased 51.4% for the three-month period ended June 30, 2007, as
compared to the same period in the prior year. The new reimbursement category created by CMS for
trans-filling systems that went into effect on January 1, 2007, may have a positive impact on the
market for trans-filling systems such as the TOTAL O2 system. However, ongoing concerns regarding
potential additional changes to reimbursement procedures continue to negatively impact sales of the
Total O2 System.
Sales to foreign distributors represented 9.9% and 20.5% of net sales for the three-month periods
ended June 30, 2007 and 2006, respectively. Foreign sales declined by 64.9% for the three- month
period as compared to the same period in the previous year. This decrease was driven by an 84.1%
decrease in conserver sales for the three-month period ended June 30, 2007, as compared to the same
period in the prior year. Notwithstanding these declines, management believes there may be
substantial growth opportunities for the Companys products in a number of foreign markets, and
currently expects an increase in sales to foreign distributors during the upcoming twelve months.
However, quarter-to-quarter sales may fluctuate depending on the timing of shipments. All foreign
sales are denominated in US dollars.
Cost of sales as a percent of net sales increased from 66.9% to 80.0% for the three-month period
ended June 30, 2007, respectively, as compared to the same period in the prior year. The increase
in cost of sales as a percentage of net sales was primarily due to the decrease in sales as
compared to consistent fixed manufacturing costs, as well as continued downward price pressures in
the marketplace and an increase in sales to high volume purchasers that receive discounted rates.
We currently expect downward price pressure for the foreseeable future.
Selling, general, and administrative expenditures increased from 31.1% to 39.0% as a percentage of
net sales for the three-month period ended June 30, 2007, as compared to the same period in the
prior year. While the Companys ongoing cost reduction efforts have decreased actual selling,
general, and administration expenditures, decreases in sales revenues have resulted in selling,
general, and administrative costs increasing as a percentage of net sales. Research and development
expenses increased by $126,000 for the three-month period ended June 30, 2007, as compared to the
same period in the prior year. Currently management expects research and development expenditures
to total approximately $1,754,000 in the fiscal year ending March 31, 2008, on projects to enhance
and expand the Companys product line. During fiscal year 2007, the Company spent $1,466,000 on
research and development.
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. The Company
has Federal net operating loss carryforwards of $1,459,000 expiring in 2027 and California net
operating loss carryforwards of $3,442,000 expiring in 2013. At June 30, 2007, the Company has
fully reserved against all of its Federal and State net operating loss carryforwards. The Company
will continue to assess the valuation allowance and to the extent it is determined that such
allowance is no longer required, the tax benefit of the remaining net deferred tax assets will be
recognized in the future.
Financial Condition
General
At June 30, 2007, the Company had cash totaling $261,000 or 2.6% of total assets, as compared to
$375,000 (3.2% of total assets) at March 31, 2007. Net working capital decreased from $7,266,000
at March 31, 2007, to $6,072,000 at June 30, 2007. Net accounts receivable decreased $894,000
during the three months ended June 30, 2007, due to the decrease in sales, factoring of a portion
of the Companys accounts receivable balance, and the timing of payments from significant
customers. 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 decreased $687,000. The Company attempts to maintain sufficient inventories to
meet its customer needs as orders are received and new products are introduced. 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 to target amounts, then inventories
in subsequent periods will increase more rapidly as inventory balances are replenished. The Company
experienced a significant inventory build up in the latter part of fiscal 2005 to fill certain
customer orders and anticipated customer orders of the SAGE device. Certain of these orders did
not materialize or were deferred. As of June 30, 2007, the Company has a $769,000 reserve against
slow-moving inventories related to the build-up of SAGE inventory.
Liquidity and Capital Resources
Historically, the Company has depended primarily upon its cash flow from operations to finance its
inventory and operating expenses and to meet its capital requirements. However, recent operating
trends have required the Company to seek outside financing in order to enhance its cash resources.
The Companys cash flow for the three months ended June 30, 2007, was negative and the Company
cannot predict when it will generate a positive cash flow from operations. The Company anticipates
capital expenditures during the next twelve months to be approximately $100,000. Moreover, the
Companys efforts to expand its product line and enter the sleep disorder market may require
significant cash resources for product development, manufacturing, and marketing.
In March 2007, the Company entered into a one-year factoring arrangement that provided for the sale
of up to $1,500,000 of the Companys accounts receivable. Assignments under the agreement incurred
interest at the banks prime rate plus two percent (2%) to three percent (3%) depending on the
total accounts receivable balance. The Company had a minimum monthly interest payment of $6,000
beginning April 2007. The Company voluntarily terminated the factoring agreement on July 30, 2007.
On July 30, 2007, the Company entered into a financing transaction with Calliope Capital
Corporation , a Delaware corporation (the Investor) pursuant to which the Company issued to the
Investor a $750,000 convertible term note (Convertible Note) and a $2,750,000 revolving credit
line (Credit Line), all secured by the Companys assets. The Convertible Note is payable in equal
installments over 36 months and bears interest at prime plus 2%, and the Credit Line bears interest
at prime plus 1.5%. A portion of the financing was used to pay all outstanding obligations on the
Companys factoring arrangement.
At the Investors option, the Convertible Note may be converted into shares of the Companys common
stock any time during the term of the note at a conversion price of $1.18. In addition, warrants to
purchase up to 976,744 shares of the Companys common stock were issued to the Investor with an
exercise price of $1.24 per share. The Investor was granted registration rights with respect to the
shares underlying the warrants. The warrants include a lock-up feature for a period of 12 months
after any warrants are exercised.
The following table aggregates all of the Companys material contractual obligations as of June 30,
2007:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
|
|
|
Contractual |
|
|
|
|
|
Less than 1 |
|
1 3 |
|
3-5 |
|
After 5 |
Obligations |
|
Total |
|
Year |
|
Years |
|
Years |
|
Years |
Operating lease
obligations |
|
$ |
467,000 |
|
|
$ |
462,000 |
|
|
$ |
5,000 |
|
|
|
|
|
|
|
|
|
Minimum royalty
obligations |
|
$ |
2,039,000 |
|
|
$ |
530,000 |
|
|
$ |
1,382,000 |
|
|
$ |
90,000 |
|
|
$ |
37,000 |
|
Employee obligations |
|
$ |
320,000 |
|
|
$ |
160,000 |
|
|
$ |
160,000 |
|
|
|
|
|
|
|
|
|
Capital lease
obligations |
|
$ |
2,000 |
|
|
$ |
2,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Factoring Agreement |
|
$ |
54,000 |
|
|
$ |
54,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease commitments consist primarily of a real property lease for the Companys
corporate office, as well as minor equipment leases. Payments for these lease commitments have
been provided for by cash flows generated from operations. Please see Note 8 to the financial
statements in the 2007 Annual Report.
Employee obligations consist of an employment agreement (the Employment Agreement) with Thomas E.
Jones, Chairman of the Board of Directors. The Employment Agreement does not have a specific term
and provides for a base salary of $160,000 per year, which is subject to annual review of the Board
of Directors. The Employment Agreement may be terminated at any time by the Company, with or
without cause, and may be terminated by Mr. Jones upon 90-days notice. If Mr. Jones resigns or is
terminated for cause (as defined in the Employment Agreement), he is entitled to receive only his
base salary and accrued vacation through the effective date of his resignation or termination. If
Mr. Jones is terminated without cause, he is entitled to receive a severance benefit in accordance
with the Companys Severance and Change of Control Plan, or if not applicable, a severance benefit
equal to 200% of his salary and incentive bonus for the prior fiscal year. In estimating its
contractual obligation,
the Company has assumed that Mr. Jones will voluntarily retire at the end of the year he turns 65
and that no severance benefit will be payable. This date may not represent the actual date the
Companys payment obligations under the Employment Agreement are extinguished.
The Company has not adopted any programs that provide for post-employment retirement benefits;
however, it has on occasion provided such benefits to individual employees. The Company does not
have any off-balance sheet arrangements with any
special purpose entities or any other parties, does not enter into any transactions in derivatives,
and has no material transactions with any related parties.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ significantly from those estimates under different assumptions and
conditions. Management believes that the following discussion addresses the accounting policies
and estimates that are most important in the portrayal of the Companys financial condition and
results.
Allowance for doubtful accounts the Company provides a reserve against receivables for estimated
losses that may result from our customers inability to pay. The amount of the reserve is based on
an analysis of known uncollectible accounts, aged receivables, historical losses, and
credit-worthiness. Amounts later determined and specifically identified to be uncollectible are
charged or written off against this reserve. The likelihood of material losses is dependent on
general economic conditions and numerous factors that affect individual accounts.
Inventories the Company provides a reserve against inventories for excess and slow moving items.
The amount of the reserve is based on an analysis of the inventory turnover for individual items in
inventory. The likelihood of material write-downs is dependent on customer demand and competitor
product offerings.
Intangible and long-lived assets The Company assesses whether or not there has been an impairment
of intangible and long-lived assets in evaluating the carrying value of these assets. Assets are
considered impaired if the carrying value is not recoverable over the useful life of the asset. If
an asset is considered impaired, the amount by which the carrying value exceeds the fair value of
the asset is written off. The likelihood of a material change in the Companys reported results is
dependent on each assets ability to continue to generate income, loss of legal ownership or title
to an asset, and the impact of significant negative industry or economic trends.
Deferred income taxes the Company provides a valuation allowance to reduce deferred tax assets to
the amount expected to be realized. The likelihood of a material change in the expected
realization of these assets depends on the Companys ability to generate future taxable income.
Revenue recognition The Company recognizes revenue when title and risk of loss transfers to the
customer and the earnings process is complete. Under a sales-type lease agreement, revenue is
recognized at the time of shipment with interest income recognized over the life of the lease. The
Company records all shipping fees billed to customers as revenue, and related costs as cost of
goods sold, when incurred.
Recently Issued Accounting Standards
Accounting standards promulgated by the Financial Accounting Standards Board change periodically.
Changes in such standards may have an impact on the Companys future financial position.
In June 2006, the Financial Accounting Standards Board ratified EITF Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income
Statement. The EITF provides guidance on the proper presentation of tax assessed by a
governmental authority that is directly imposed on a revenue-producing transaction between a seller
and a customer and requires disclosure of the Companys accounting policy decision. The consensus
becomes effective for periods beginning after December 15, 2006. The implementation of this
interpretation did not have a significant impact on the Companys financial statements.
In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48, Accounting
for Uncertainty in Income Taxes. Interpretation No. 48 prescribes a recognition threshold and
measurement attribute for financial statement recognition and measurement of a tax position taken,
or expected to be taken, in a tax return. The Interpretation also provides guidance on
derecognition, classification, interest and penalties, accounting in interim periods, disclosure,
and transition. This Interpretation is effective for fiscal years beginning after December 15,
2006. The implementation of this interpretation did not have a significant impact on the Companys
financial statements.
In September 2006, the Financial Accounting Standards Board issued Staff Accounting Bulletin No.
108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements. SAB 108 requires registrants to quantify misstatements using both the
balance sheet and income-statement approaches and to evaluate whether either approach results in
quantifying an error that is material in light of relevant quantitative and qualitative factors.
The requirements are effective for annual financial statements covering the first fiscal year
ending after November 15, 2006. The implementation of this interpretation did not have a
significant impact on the Companys financial statements.
In September 2006, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 157 Share-Based Payment. SFAS 157 establishes a single
authoritative definition of fair value, sets out a framework for measuring fair value, and requires
additional disclosures about fair-value measurements. SFAS 157 applies only to fair-value
measurements that are already required or permitted by other accounting standards. The Statement
is effective for fair-value measures already required or permitted by other standards for financial
statements issued for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. The Company is evaluating the impact of this interpretation and does not
anticipate a significant impact to its financial statements upon implementation.
In September 2006, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 158 Employers Account for Defined Benefit Pension and Other
Post-retirement Plans. SFAS 158 requires employers to recognize on their balance sheets the
funded status of pension and other post-retirement benefit plans as of June 30, 2007, for the
calendar-year public companies. SFAS 158 will also require fiscal-year-end measurements of plan
assets and benefit obligations, eliminating the use of earlier measurement dates currently
permissible. The Company does not have a defined benefit pension plan, nor does it have any other post-retirement plans. The
implementation of this interpretation did not have a significant impact on the Companys financial
statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risks
The Company has no significant exposure to market risk sensitive instruments or contracts.
Item 4. Controls and Procedures
The Company has evaluated the effectiveness of the design and operation of its disclosure controls
and procedures as of June 30, 2007 (the Evaluation Date). Such evaluation was conducted under
the supervision and with the participation of the Companys Chief Executive Officer (CEO) and its
Chief Financial Officer (CFO). Based upon such evaluation, the Companys CEO and CFO have
concluded that, as of the Evaluation Date, the Companys disclosure controls and procedures were
effective to ensure that the Company record, process, summarize, and report information required to
be disclosed by the Company in its quarterly reports filed under Securities Exchange Act within the
time periods specified by the Securities and Exchange Commissions rules and forms and accumulated
and communicated to our management, including our Chief Executive Officer and our Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure. There have been
no significant changes in the Companys internal control over financial reporting that occurred
during the Companys most recent fiscal quarter that have materially affected, or are reasonably
likely to materially affect, the Companys internal control over financial reporting.
Part II
Other Information
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors.
Because of the following risk factors, past performance may not be indicative of our future
operating results. Forward-looking statements in this report reflect the Companys current views
and expectations. However, such forward looking statements are subject to the risks and
uncertainties described herein which may cause future operating results to differ materially from
currently anticipated results.
Our future results depend upon our ability to successfully introduce new products.
We operate in a market which is subject to continuing technological change. In order to stay
abreast of new technological developments, we must continually improve our products. Moreover,
there is significant price pressure on our primary product line, oxygen conservers. As a result,
in order to mitigate the price pressure on our conservers, we must introduce innovative new
products, and we are seeking to expand our product offerings.
There are a number of significant risks involved with new product introductions. Problems
encountered in the design and development of new products or in obtaining
regulatory clearances to market the products may impair our ability to introduce any new product on
a timely basis. Competitors may leapfrog our development efforts, particularly if our development
efforts are delayed.
The commercial success of any new products we do introduce will depend upon the health care
communitys perception of such products capabilities, clinical efficacy, and benefit to patients.
In addition, prospective sales will be impacted by the degree of acceptance achieved among home
care providers and patients requiring supplementary oxygen. Our prospective customers may be
reluctant to try unproven products which we introduce. Our ability to successfully introduce new
products in a new market sector such as the sleep disorder market will also be complicated by our
lack of experience in this market. Thus, the success of any new products we may introduce is
unpredictable and our future results may suffer if we are unable to successfully introduce new
products.
Our operating results, profitability and operating margins have been adversely affected by price
pressure on our principal products.
During the past several years, there has been significant price pressure on oxygen conservers and
therapeutic devices. Thus, though our total domestic unit sales of conservers and therapeutic
devices for the first three months of fiscal 2008 declined by approximately 5% from the same period
in fiscal 2007, revenues from the sales of such products declined by 9%. This trend is magnified
by the continuing consolidation of the home care industry as national chains typically negotiate
for quantity discounts. We expect continuing price pressure on our principal products for the
foreseeable future.
We are highly dependent upon a limited number of large customers, which may increase the volatility
of our future operating results.
The home health care industry is undergoing significant consolidation. As a result, the market for
our products is increasingly influenced by major national chains. Four major national chains
accounted for 56% and 43% of our sales for the three-months ended June 30, 2007 and 2006,
respectively. One customer accounted for 48% and 37% of net sales for the three-months ended June
30, 2007 and 2006, respectively. Future sales may be increasingly dependent upon a limited number
of customers which increases the risk that our financial performance may be adversely affected if
one or more of these customers reduces their purchases of our products or terminates its
relationship with us. During the past two years, a significant decline in orders from one national
chain contributed to our decline in revenues. In addition, our future sales to another national
chain may be adversely affected by that chains decision to add a second source for certain
products where we had been the sole supplier.
We are dependent upon a single product line, which increases our vulnerability to adverse
developments affecting the market for supplementary oxygen.
Although we market a range of products, all of our current products are designed for patients
requiring supplementary oxygen. Unlike some of our competitors, we are not a diversified provider
of home health care products. As a result, our future performance is dependent upon developments
affecting this narrow segment of the health care market. Adverse regulatory or economic
developments affecting the market for supplementary oxygen will have a significant impact on our
performance.
Changes and prospective changes in the administration of health care may disrupt the market for our
products, resulting in decreased profitability.
Approximately 85% of home health care patients are covered by Medicare and other government
programs. Federal law has altered the payment rates available to providers of Medicare services.
The Medicare Improvement and Modernization Act of 2003 has resulted in several years of reductions
in reimbursement for home oxygen. In February 2006, reimbursement procedures were modified again,
with a new requirement that ownership of home oxygen equipment be transferred to the patient after
36 months. New proposals related to reimbursement for home health care are routinely introduced in
Congress. On November 1, 2006, the Centers for Medicare and Medicaid Services (CMS) announced new
reimbursement rates that took effect on January 1, 2007. These new rates include a new
reimbursement category for transfilling systems like the Companys TOTAL O2 delivery system, which
may have a positive impact on the market for these types of devices. At the same time the current
Federal budget negotiations involve discussions that may reduce the time period that must pass
before title to equipment that an oxygen patient is using transfers to the patient. A significant
reduction would likely have a negative impact on demand for the Companys products.
As a result, we expect changes in reimbursement policies to continue to exert downward pressure on
the average selling price of our products. Moreover, the uncertainty resulting from constant
change in reimbursement policies has had a deleterious affect upon our market, causing many home
care providers to delay or cut back their product purchase plans as they seek to evaluate the
impact of the new policies.
We operate in a highly competitive environment which has contributed to our reduced operating
margins.
Our success in the early 1990s drew a significant number of competitors into the home oxygen
market. Some of these competitors have substantially greater marketing and financial resources
compared with those of the Company. While we believe that our product features and reputation for
quality will continue to be competitive advantages, we note that our market is increasingly
dominated by price competition. Some of our competitors have successfully introduced lower priced
products that do not provide oxygen conserving capabilities comparable to our products. We expect
competition to remain keen, with continuing emphasis on price competition for oxygen conservers and
therapeutic devices.
Our dependence on outside financing to pursue our growth strategy could adversely affect our
operating results and the future price of our stock.
We recently entered into a financing arrangement with an outside investor (the Investor) to
enhance our ability to pursue our business strategy. Under this financing arrangement, we will
incur interest expense ranging from 1.5% to 2.5% above prime on outstanding amounts due to the
Investor. Such interest expense will reduce our net income (or increase our net loss.) The
financing arrangements include a Convertible Note that may be converted at the option of the
Investor into shares of our common stock at $1.18 per share. In addition, we issued warrants to
purchase nearly one million shares of our common stock at $1.24 per share in connection with this
financing. The Investor
has been granted registration rights with respect to the shares issuable pursuant to the
Convertible Note and the warrants. The potential issuance of a substantial number of our shares at
$1.18 and $1.24 could depress the future price of our stock and may be dilutive to certain of our
shareholders. Although management believes these financing
arrangements are adequate to meet the Companys current needs, we
may need to raise additional funds in the future. Should it become
necessary however, there can be no assurance that additional
financing will be available on favorable terms or at all.
If we are unable to stay abreast of continuing technological change, our products may become
obsolete, resulting in a decline in sales and profitability.
The home health care industry is characterized by rapid technological change. Our products may
become obsolete if we do not stay abreast of such changes and introduce new and improved products.
We have limited internal research and development capabilities. Historically, we have contracted
with outside parties to develop new products. Some of our competitors have substantially greater
funds and facilities to pursue development of new products and technologies. If we are unable to
maintain our technological edge, our product sales will likely decline, as will our profitability.
Failure to protect our intellectual property rights could result in a loss of market share.
The success of our business is dependent to a significant extent upon our ability to develop,
acquire, and protect proprietary technologies related to the delivery of supplementary oxygen. We
pursue a policy of protecting our intellectual property rights through a combination of patents,
trademarks, license agreements, confidentiality agreements, and protection of trade secrets. To
the extent that our products do not receive patent protection, competitors may be able to market
substantially similar products, thereby eroding our market share. Moreover, claims that our
products infringe upon the intellectual property rights of any third party could impair our ability
to sell certain products or could require us to pay a license fee, thereby increasing our costs.
Our profitability would be adversely affected if we incur uninsured losses due to product liability
claims.
The nature of our business subjects us to potential legal actions asserting that we are liable for
personal injury or property loss due to alleged defects in our products. Although we maintain
product liability insurance in an amount which we believe to be customary for our size, there can
be no assurance that the insurance will prove sufficient to cover the costs of defense and/or
adverse judgments entered against the Company. To date, we have not experienced any significant
losses due to product liability claims. However, given the use of our products by infirm patients,
there is a continuing risk that such claims will be asserted against us.
Our dependence upon third-party suppliers exposes us to the risk that our ability to deliver
products may be adversely affected if the suppliers fail to deliver quality components on a timely
basis.
While we perform most of our manufacturing internally, some of our products depend upon components
or processes provided by independent companies. We expect to continue to use outside firms for
various processes for the foreseeable future. From time to time, we have experienced problems with
the reliability of components produced by third-party suppliers. We do not have any long-term
supply contracts that are not readily terminable, and we believe there are alternative sources of
supply with respect to all the
components we acquire from third parties. Nonetheless, any reliability or quality problem
encountered with a supplier could disrupt our manufacturing process, thereby delaying our ability
to deliver on a timely basis product and potentially harming our reputation with our customers.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None.
Item 6. Exhibits
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.)
(1)
10.20 OXYCOIL tubing License Agreement with Mary Smart (licensed under the name Respi-Coil).
(2)
10.23 Summary plan description for CHAD Therapeutics, Inc. Employee Savings and Retirement Plan
(3)
10.24 1994 Stock Option Plan (4)
10.25 Lease on real property at 21622 Plummer Street, Chatsworth, California (4)
10.26 TOTAL O2 Delivery System License Agreement, as amended, with the Carleton Life Support
Division of Litton Industries, Inc. (5)
10.27 2004 Equity Incentive Plan (6)
10.28 Security Agreement dated July 30, 2007 (7)
10.29 Registration Rights Agreement dated July 30, 2007 (7)
10.30 Secured Convertible Term Note dated July 30, 2007 (7)
10.31 Secured Revolving Note dated July 30, 2007 (7)
10.32 Warrant dated July 30, 2007 (7)
31.1 Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CEO
31.2 Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CFO
32* Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 2002
99.1 Press release dated August 13, 2007
* The information in Exhibit 32 shall not be deemed filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the
liabilities of that section, nor shall they be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, or the Exchange Act
(including this quarterly report), unless CHAD Therapeutics specifically incorporates the foregoing
information into those documents by reference.
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(1) |
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Previously filed as an Exhibit to the Registrants
Registration Statement on Form S-18, File No. 2-83926. |
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(2) |
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Previously filed as an Exhibit to the Registrants Annual Report
on Form 10-K for the year ended March 31, 1986. |
|
(3) |
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Previously filed as an Exhibit to the Registrants Annual Report
on Form 10-K for the year ended March 31, 1993. |
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(4) |
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Previously filed as an exhibit to the Registrants Annual Report on Form
10-K for the year ended March 31, 1996. |
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(5) |
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Previously filed as an exhibit to the Registrants Annual Report on Form
10-K for the year ended March 31, 1998. |
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(6) |
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Previously filed as Appendix A of the Registrants Proxy Statement
for the 2004 Annual Shareholders Meeting. |
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(7) |
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Previously filed as an Exhibit to the Registrants Form 8-K dated
August 3, 2007. |
SIGNATURE
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.
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CHAD THERAPEUTICS, Inc.
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(Registrant)
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Date 08/14/2007 |
/s/ Earl L. Yager
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Earl L. Yager |
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President and Chief Executive Officer |
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Date 08/14/2007 |
/s/ Tracy A. Kern
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Tracy A. Kern |
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Chief Financial Officer |
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INDEX TO EXHIBITS
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Exhibit No. |
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Description of Exhibits |
31.1
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Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CEO |
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31.2
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Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CFO |
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32*
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Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 2002 |
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99.1
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Press release dated August 13, 2007 |
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* |
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The information in Exhibit 32 shall not be deemed filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the
liabilities of that section, nor shall they be deemed incorporated by reference in any filing under
the Securities Act of 1933, as amended, or the Exchange Act (including this quarterly report),
unless CHAD Therapeutics specifically incorporates the foregoing information into those documents
by reference. |