e10vq
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934 |
For Quarterly Period Ended: September 30, 2006
Or
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o |
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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 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 September 30, 2006, the registrant had 10,169,000 shares of its common stock outstanding.
TABLE OF CONTENTS
CHAD THERAPEUTICS, INC.
Condensed Balance Sheets
September 30, 2006 and March 31, 2006
(Unaudited)
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September 30, |
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March 31, |
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2006 |
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2006 |
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ASSETS
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Current assets: |
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Cash |
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$ |
1,777,000 |
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$ |
935,000 |
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Accounts receivable, less allowance for
doubtful accounts of $54,000 at
September 30, 2006, and $52,000 at
March 31, 2006 |
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2,568,000 |
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3,220,000 |
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Income taxes refundable |
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182,000 |
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383,000 |
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Inventories (Note 5) |
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6,303,000 |
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6,381,000 |
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Prepaid expenses and other assets |
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146,000 |
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178,000 |
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Deferred income taxes |
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640,000 |
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666,000 |
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Total current assets |
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11,616,000 |
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11,763,000 |
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Property and equipment, at cost |
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6,163,000 |
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6,101,000 |
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Less accumulated depreciation |
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5,345,000 |
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5,151,000 |
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Net property and equipment |
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818,000 |
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950,000 |
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Intangible assets, net |
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1,073,000 |
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972,000 |
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Deferred income taxes |
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610,000 |
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600,000 |
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Other assets |
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44,000 |
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71,000 |
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Total assets |
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$ |
14,161,000 |
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$ |
14,356,000 |
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LIABILITIES AND SHAREHOLDERS EQUITY
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Current liabilities: |
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Accounts payable |
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$ |
923,000 |
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$ |
522,000 |
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Accrued expenses |
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1,206,000 |
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1,435,000 |
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Total current liabilities |
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2,129,000 |
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1,957,000 |
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Other long-term liabilities |
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4,000 |
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Total liabilities |
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2,129,000 |
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1,961,000 |
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Shareholders equity: |
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Common shares, $.01 par value, authorized
40,000,000 shares; 10,169,000 and 10,158,000
shares issued and outstanding |
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13,473,000 |
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13,413,000 |
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Accumulated deficit |
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(1,441,000 |
) |
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(1,018,000 |
) |
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Total shareholders equity |
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12,032,000 |
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12,395,000 |
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Total liabilities and shareholders equity |
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$ |
14,161,000 |
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$ |
14,356,000 |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the three months ended September 30, 2006 and 2005
(Unaudited)
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Three Months Ended |
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September 30, |
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2006 |
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2005 |
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Net sales |
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$ |
4,983,000 |
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$ |
5,375,000 |
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Cost of sales |
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3,366,000 |
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3,594,000 |
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Gross profit |
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1,617,000 |
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1,781,000 |
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Costs and expenses: |
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Selling, general, and administrative |
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1,682,000 |
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1,699,000 |
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Research and development |
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322,000 |
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435,000 |
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Total costs and expenses |
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2,004,000 |
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2,134,000 |
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Operating loss |
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(387,000 |
) |
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(353,000 |
) |
Other income |
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16,000 |
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13,000 |
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Loss before income taxes |
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(371,000 |
) |
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(340,000 |
) |
Income tax benefit |
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(64,000 |
) |
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(130,000 |
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Net loss |
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$ |
(307,000 |
) |
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$ |
(210,000 |
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Basic loss per share |
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$ |
(0.03 |
) |
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$ |
(0.02 |
) |
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Diluted loss per share |
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$ |
(0.03 |
) |
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$ |
(0.02 |
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Weighted shares outstanding: |
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Basic |
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10,169,000 |
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10,141,000 |
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Diluted |
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10,169,000 |
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10,141,000 |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the six months ended September 30, 2006 and 2005
(Unaudited)
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Six Months Ended |
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September 30, |
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2006 |
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2005 |
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Net sales |
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$ |
10,459,000 |
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$ |
11,270,000 |
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Cost of sales |
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7,028,000 |
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7,388,000 |
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Gross profit |
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3,431,000 |
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3,882,000 |
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Costs and expenses: |
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Selling, general, and administrative |
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3,384,000 |
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3,543,000 |
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Research and development |
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657,000 |
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767,000 |
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Total costs and expenses |
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4,041,000 |
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4,310,000 |
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Operating loss |
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(610,000 |
) |
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(428,000 |
) |
Other income |
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39,000 |
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19,000 |
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Loss before income taxes |
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(571,000 |
) |
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(409,000 |
) |
Income tax benefit |
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(148,000 |
) |
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(157,000 |
) |
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Net loss |
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$ |
(423,000 |
) |
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$ |
(252,000 |
) |
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Basic loss per share |
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$ |
(0.04 |
) |
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$ |
(0.02 |
) |
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Diluted loss per share |
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$ |
(0.04 |
) |
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$ |
(0.02 |
) |
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Weighted shares outstanding: |
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Basic |
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10,169,000 |
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10,137,000 |
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Diluted |
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10,169,000 |
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10,137,000 |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
Condensed Statement of Shareholders Equity
For the six months ended September 30, 2006
(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, 2006 |
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10,158,000 |
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$ |
13,413,000 |
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$ |
(1,018,000 |
) |
Stock-based compensation options |
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20,000 |
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Stock-based
compensation - restricted stock |
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11,000 |
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40,000 |
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Net loss |
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(423,000 |
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Balance at September 30, 2006 |
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10,169,000 |
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13,473,000 |
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$ |
(1,441,000 |
) |
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See accompanying notes to condensed financial statements.
CHAD THERAPEUTICS, INC.
Condensed Statement of Cash Flows
For the six months ended September 30, 2006 and 2005
(Unaudited)
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Six Months Ended |
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September 30, |
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2006 |
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2005 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(423,000 |
) |
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$ |
(252,000 |
) |
Adjustments to reconcile net loss to net cash
provided by operating activities: |
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Depreciation and amortization of property and equipment |
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194,000 |
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214,000 |
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Amortization of intangibles |
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21,000 |
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20,000 |
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Provision for losses on receivables |
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20,000 |
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21,000 |
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Decrease (increase) in deferred income taxes |
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16,000 |
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Stock-based compensation |
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60,000 |
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Changes in assets and liabilities: |
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Decrease (increase) in accounts receivable |
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632,000 |
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711,000 |
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Decrease (increase) in inventories |
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78,000 |
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394,000 |
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Decrease (increase) in income taxes refundable |
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201,000 |
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(203,000 |
) |
Decrease (increase) in prepaid expenses and other assets |
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59,000 |
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(57,000 |
) |
Increase (decrease) in accounts payable |
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401,000 |
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7,000 |
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Increase (decrease) in accrued expenses |
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(229,000 |
) |
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(194,000 |
) |
Increase (decrease) in income taxes payable |
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(200,000 |
) |
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Net cash
provided by operating activities |
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1,030,000 |
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461,000 |
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Cash flows from investing activities: |
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Additions to intangible assets |
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(122,000 |
) |
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(81,000 |
) |
Capital expenditures |
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(62,000 |
) |
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(133,000 |
) |
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Net cash used in investing activities |
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(184,000 |
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(214,000 |
) |
Cash flows from financing activities: |
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Other long-term liabilities |
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(4,000 |
) |
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10,000 |
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Net cash
(used in) provided by financing activities |
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(4,000 |
) |
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10,000 |
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Net increase in cash |
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842,000 |
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257,000 |
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Cash beginning of period |
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935,000 |
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177,000 |
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Cash end of period |
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$ |
1,777,000 |
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$ |
434,000 |
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Supplemental disclosure of cash flow information: |
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Acquisition of capital assets through capital lease |
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$ |
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$ |
14,000 |
|
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 six-month period ended September 30, 2006, are not necessarily
indicative of the results expected for the year ended March 31, 2007. 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, 2006, 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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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 costs of good
sold, when incurred. |
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3. |
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Major Customers |
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Three Months Ended |
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Six Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Customer A** |
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39.5 |
% |
|
|
38.8 |
% |
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|
38.0 |
% |
|
|
37.6 |
% |
Customer B |
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|
10.5 |
% |
|
|
10.0 |
% |
|
|
11.7 |
% |
|
|
* |
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|
* |
|
Indicates sales less than 10% of the Companys net sales |
|
** |
|
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. |
|
4. |
|
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. 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 any one account over $100,000. At September 30, 2006, the
amount at risk was approximately $1,677,000. |
|
|
The significant outstanding accounts receivable balances in 2006 were as follows: |
|
|
|
|
|
|
|
|
|
|
|
September 30 |
|
March 31 |
Customer A** |
|
|
32.8 |
% |
|
|
25.4 |
% |
Customer B** |
|
|
10.5 |
% |
|
|
* |
|
Customer C |
|
|
* |
|
|
|
21.6 |
% |
Customer D |
|
|
15.3 |
% |
|
|
* |
|
|
|
|
* |
|
Indicates receivables balance less than 10% of the Companys net accounts receivable balance. |
|
** |
|
Indicates national chain customer. |
|
|
Inventories in 2006 are summarized as follows: |
|
|
|
|
|
|
|
|
|
|
|
September 30 |
|
|
March 31 |
|
Finished goods |
|
$ |
2,097,000 |
|
|
$ |
1,706,000 |
|
Work-in-process |
|
|
1,647,000 |
|
|
|
1,234,000 |
|
Raw materials |
|
|
2,559,000 |
|
|
|
3,441,000 |
|
|
|
|
|
|
|
|
|
|
$ |
6,303,000 |
|
|
$ |
6,381,000 |
|
|
|
|
|
|
|
|
6. |
|
Line of Credit |
|
|
|
In December 2005, the Company entered into a $1 million revolving line of credit agreement
that expires in December 2006. Advances under the line of credit bear interest at the banks
prime rate (8.25% at September 30, 2006) and are secured by inventories and accounts
receivable. Under the terms of the credit agreement, the Company is required to maintain a
specific working capital, net worth, profitability levels, and other specific ratios. In
addition, the agreement prohibits the payment of cash dividends and contains certain
restrictions on the Companys ability to borrow money or purchase assets or interests in other
entities without prior written consent of the bank. At September 30, 2006, the Company was not
in compliance with certain of the covenants related to profitability and is currently
renegotiating changes to the line of credit. There were no borrowings under the line of credit
at September 30, 2006. |
|
7. |
|
Leasing Arrangements |
|
|
|
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 $7,000 is included in accounts payable. Amortization of plant equipment under
capital leases is included in depreciation expense. |
8. |
|
Loss Per Common Share |
|
|
|
Following is a reconciliation of the numerators and denominators used in the calculation of
basic and diluted loss per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Basic loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator-net loss |
|
$ |
(307,000 |
) |
|
$ |
(210,000 |
) |
|
$ |
(423,000 |
) |
|
$ |
(252,000 |
) |
Denominator-weighted average
common shares outstanding |
|
|
10,169,000 |
|
|
|
10,141,000 |
|
|
|
10,169,000 |
|
|
|
10,137,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic loss per share |
|
$ |
(0.03 |
) |
|
$ |
(0.02 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.02 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator-net loss |
|
$ |
(307,000 |
) |
|
$ |
(210,000 |
) |
|
$ |
(423,000 |
) |
|
$ |
(252,000 |
) |
Denominator-weighted average
common shares outstanding |
|
|
10,169,000 |
|
|
|
10,141,000 |
|
|
|
10,169,000 |
|
|
|
10,137,000 |
|
Diluted effect of common stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,169,000 |
|
|
|
10,141,000 |
|
|
|
10,169,000 |
|
|
|
10,137,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted loss per share |
|
$ |
(0.03 |
) |
|
$ |
(0.02 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.02 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options to purchase 935,000 shares of common stock at prices ranging from $0.50 to $11.50
per share and 1,003,000 shares of common stock at prices ranging from $0.50 to $12.54 were not
included in the computation of diluted earnings per share for the three and six-month periods
ended September 30, 2006 and 2005, respectively, because their effect would have been
anti-dilutive. |
|
9. |
|
Income Tax Expense |
|
|
|
Based on managements earnings projections for the fiscal year ended 2007, the Company has
forecasted an effective tax rate of 26 percent. The Company has California net operating loss
carryforwards of $2,679,000 of which $606,000 expires in 2007 and the remaining balance expires
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 be realized and
has established a valuation allowance against the California net operating loss carryforward
expiring in 2007. |
10. |
|
Geographic Information |
|
|
|
The Company has one reportable operating segment. Geographic information regarding the
Companys net sales is as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
United States |
|
$ |
3,788,000 |
|
|
$ |
4,547,000 |
|
|
$ |
8,142,000 |
|
|
$ |
9,656,000 |
|
Canada |
|
|
33,000 |
|
|
|
40,000 |
|
|
|
87,000 |
|
|
|
96,000 |
|
Japan |
|
|
69,000 |
|
|
|
72,000 |
|
|
|
194,000 |
|
|
|
260,000 |
|
Europe |
|
|
1,004,000 |
|
|
|
633,000 |
|
|
|
1,858,000 |
|
|
|
1,105,000 |
|
All other countries |
|
|
89,000 |
|
|
|
83,000 |
|
|
|
178,000 |
|
|
|
153,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
4,983,000 |
|
|
$ |
5,375,000 |
|
|
$ |
10,459,000 |
|
|
$ |
11,270,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All long-lived assets are located in the United States. |
|
|
|
Sales of OXYMATIC®, LOTUS and CYPRESS OXYPneumatic® conservers and SAGE Therapeutic devices
accounted for 72% and 69% of the Companys sales for the six-month periods ended September 30,
2006 and 2005, respectively, and 73% and 71% of the Companys sales for the three-month periods
ended September 30, 2006 and 2005, respectively. |
|
11. |
|
Stock Option Plan |
|
|
|
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 six-month period ended September 30, 2006, 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 six-month period ended September 30, 2006 has
been reduced for estimated forfeitures. For the six-month period ended September 30, 2006
stock-based compensation expense of $60,000 was recorded to selling, general, and administrative
expenses. Of the $60,000 in stock-based compensation, $20,000 related to FAS 123R option
expense with the remaining $40,000 related to restricted stock issued to directors that vested
April 1, 2006. 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 705,000 were available for future grant at September 30, 2006.
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. In fiscal year 2006, 40,000
options were issued with vesting periods less than one year. All options granted to date have
ten-year contractual terms from the date of the grant. |
|
|
|
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 September 30, 2006. The following weighted-average assumptions were used in
calculating the fair value of stock options granted during the six months ended June 30, 2005
using the Black-Scholes option valuation model: |
|
|
|
|
|
Expected life (in years) |
|
|
8.0 |
|
Expected volatility factor |
|
|
79.0 |
% |
Risk free interest rate |
|
|
4.3 |
% |
Dividend yield |
|
|
0.0 |
|
Forfeiture rate |
|
|
4.0 |
% |
|
|
A summary of stock option activity as of and for the quarter ended September 30, 2006 is
presented below: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining |
|
|
|
|
|
|
|
|
Exercise |
|
Contractual |
|
Aggregate |
|
|
|
|
|
|
Price Per |
|
Term |
|
Intrinsic Value |
|
|
Shares |
|
Share |
|
(in years) |
|
(in thousands) |
|
|
|
Outstanding at March 31, 2006 |
|
|
945,000 |
|
|
$ |
2.22 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited or expired |
|
|
10,000 |
|
|
|
3.59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2006 |
|
|
935,000 |
|
|
$ |
2.20 |
|
|
|
4.6 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable |
|
|
898,000 |
|
|
$ |
2.22 |
|
|
|
4.5 |
|
|
$ |
|
|
Vested and expected to vest |
|
|
925,000 |
|
|
$ |
2.25 |
|
|
|
4.6 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
The Company granted 25,000 options at $3.45 per share on July 28, 2005 and 15,000 options
at $3.35 per share on August 2, 2005. The options were granted at the market price on the day
of grant, and fully vested six months subsequent to the grant date. In addition, there were
10,000 options exercised at prices ranging from $.50 to $1.00 in |
|
|
the six months ended September 30, 2005. No options were granted or exercised during the first
six months of fiscal year 2007. |
|
|
|
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 September 30, 2006 for
the options that were in-the-money at September 30, 2006. As of September 30, 2006, there was
approximately $31,000 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 13 months. |
|
|
|
Prior to the adoption of FAS 123R, the Company provided the disclosures required under FAS 123,
as amended by FAS No. 148, Accounting for Stock-Based Compensation Transitions and
Disclosures. Employee stock-based compensation expense recognized under FAS 123R was not
reflected in our results of operations for the six-month period ended September 30, 2005 as all
options were granted with an exercise price equal to the market value of the underlying common
stock on the date of the grant. The pro forma information for the three and six-months ended
September 30, 2005 is as follows: |
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
September 30, 2005 |
|
|
September 30, 2005 |
|
Net loss, as reported |
|
$ |
(210,000 |
) |
|
$ |
(252,000 |
) |
Deduct: Total stock-based employee
compensation expense determined under
fair value-based method for all awards, net
of related tax effects |
|
|
35,000 |
|
|
|
70,000 |
|
|
|
|
|
|
|
|
Pro forma net loss |
|
$ |
(245,000 |
) |
|
$ |
(322,000 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per share: |
|
|
|
|
|
|
|
|
Basic as reported |
|
$ |
(0.02 |
) |
|
$ |
(0.02 |
) |
Basic pro forma |
|
|
(0.02 |
) |
|
|
(0.03 |
) |
Diluted as reported |
|
|
(0.02 |
) |
|
|
(0.02 |
) |
Diluted proforma |
|
$ |
(0.02 |
) |
|
$ |
(0.03 |
) |
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 November 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 151 (Inventory Costs), an amendment of ARB No. 43,
Chapter 4. The statement clarifies accounting for abnormal amounts of the idle facility
expense, freight, handling costs, and spoilage and requires those items to be expensed when
incurred. SFAS 151 is applicable to inventory costs incurred during fiscal years beginning
after June 15, 2005. The |
|
|
Company adopted SFAS No. 151 on April 1, 2006, and the Company did
not incur a significant impact to its financial statements. |
|
|
|
In December 2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 123R (Share-Based Payment). SFAS 123R requires the Company
to recognize compensation expense based on the fair value of equity instruments awarded to
employees. The Company adopted SFAS 123R on April 1, 2006, and the Company did not incur a
significant impact to its financial statements. |
|
|
|
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 Company is
evaluating the impact of this interpretation and does not anticipate a significant impact to
its financial statements upon implementation. |
|
|
|
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 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 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 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. 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 December 31, 2006 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 and therefore does not anticipate a significant impact to its
financial statements upon implementation. |
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 competitive market for the Companys products.
The current 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 have been 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 November 1, 2006, the Centers for Medicare and Medicaid Services (CMS)
announced new reimbursement rates that will take 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.
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 46% and 45% of the Companys net sales for the three and six-month
periods ended September 30, 2006, respectively while one chain accounted for 39% and 38% of net
sales for the three and six-month periods ended September 30, 2006 and 2005, respectively. One
international customer accounted for 11% and 12% of net sales during the three and six-month
periods ended September 30, 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 nature of the oxygen
conserver marketplace, the Company has developed and introduced a number of new products in this
area in recent years. The first of these, the OXYMATIC® 401 conserver, received 510(k) clearance
from the Food and Drug Administration in June 2000, and shipments of the new product began in July
2000. The second, the OXYMATIC 411 conserver, was cleared in December 2000 and shipments began in
January 2001. The third, the OXYMATIC 401A and 411A conservers, received clearance in March 2001
with shipments beginning that month. The SEQUOIA OXYMATIC 300 series conservers began shipping in
December 2001, and the Company began shipment of the CYPRESS OXYPneumatic conserver in July 2002.
The Company received clearance from the FDA to market its newest oxygen conserving device, the
LOTUS Electronic Oxygen Conserver, in October 2004 and began shipment of the device in November
2005. The LOTUS Electronic Oxygen Conserver weighs less than one (1) pound and will be offered
with or without a breath-sensing alarm. It also offers additional liter flow settings and an
extended battery life of up to four months of normal usage on two AA-size batteries. Management
believes the features and improvements in these products have enabled the Company to regain some of
the market share lost in the conserver market prior to 2001 and reestablish the Company as a leader
in the conserver market.
In May of 2004, the Company received clearance from the FDA to market its SAGE Oxygen Therapeutic
Device. The SAGE device is the first in a planned family of oxygen therapeutic devices that use
the Companys proprietary technologies to sense a patients movements and automatically adjust the
rate of oxygen delivery to reduce the risk of
desaturation as activity increases. This device combines the industrys first, truly dynamic
delivery technology with the proven oxygen sensor technology in the OXYMATIC 400 series conservers.
As a result, the SAGE Oxygen Therapeutic Device addresses the common problem of oxygen
desaturation, which causes a patient to feel weak and out of breath when activity increases, while
it still improves patient ambulatory capability. This device underscores the Companys dedication
to providing home care suppliers and their patients with the widest range of home oxygen choices to
suit individual needs, preferences and disease conditions. The Company began selling the SAGE
nationwide in October 2004. No estimate can currently be made regarding the level of success the
Company may achieve with this line of products or when the additional therapeutic devices that are
now in development, and which are based on this advanced new platform, may be introduced to the
market.
In 1998, the Company introduced the TOTAL O2® Delivery System, which provides stationary oxygen for
patients at home, portable oxygen, including an oxygen conserving device for ambulatory use, and a
safe and efficient mechanism for filling portable oxygen cylinders in the home. This provides home
care dealers with a means to reduce 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 from the Food and Drug Administration to sell this product. Initial
sales of the TOTAL O2 system were adversely affected by several factors, including the overall home
oxygen market climate as well as home care providers reluctance to invest in the higher cost of
the TOTAL O2 Delivery System to achieve the lower monthly operating costs. Recent changes in home
oxygen reimbursement appear to be causing home care providers to examine their operating costs more
carefully and we believe this is improving the marketing climate for the TOTAL O2 system.
The Companys growth strategy for the future includes the following:
|
|
Development of additional oxygen conserver models, such as the
LOTUS Electronic Oxygen Conserver with a view to diversifying the
product line in order to offer customers a range of oxygen
conservation choices; |
|
|
|
An effort to expand the Companys product lines and improve
existing products through the investment in and development of new
technologies, such as proprietary sensor technology and control
software licensed in January of 2003 and the introduction of the
SAGE Oxygen Therapeutic Device in May 2004. These new
technologies should provide the Company with an opportunity to
expand its oxygen delivery product lines and potentially enter the
high-growth sleep disorder market; and |
|
|
|
A continued promotional and educational campaign with respect to
the benefits of the TOTAL O2 system. |
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 six months of fiscal
2007. 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 Outlook: Issues and Risks New Products, Consolidation of Home Care Industry,
Competition, Rapid Technological Change, and Potential Changes in the Administration of Health
Care, beginning on page 17 of the Companys 2006 Annual Report.
Results of Operations
Net sales for the three and six-month periods ended September 30, 2006, decreased by $392,000
(7.3%) and $811,000 (7.2%), respectively, as compared to the same periods in the prior year. The
primary reason for the decrease in sales for the three and six-month periods ended September 30,
2006 was price reductions on conservers. Unit sales of conservers and therapeutic devices for the
three and six months ended September 30, 2006 increased 1.4% and 4.0%, respectively, from the prior
year. However, revenues from conserver and therapeutic device sales decreased by 4.7% and 4.1% for
the three and six-month periods ended September 30, 2006 and 2005, respectively. As noted above,
management expects continued downward pressure on its average selling price. In addition, future
operating results may be increasingly dependent upon purchase decisions of a limited number of
large customers.
Revenues from TOTAL O2 sales decreased 40.8% and 29.4% for the three and six-month periods ended
September 30, 2006, respectively, as compared to the same periods in the prior year. The Company
believes that the January 2, 2006 modification of reimbursement procedures that provides for title
of equipment being used by a patient to transfer to the patient after 36 months, and pending
proposals to make further changes in reimbursement policies, is negatively impacting the Companys
sales overall and in particular sales of the TOTAL O2.
Sales to foreign distributors represented 24.0% and 22.1% of net sales for the three and six-month
periods ended September 30, 2006, respectively, representing a 44.3% and a 43.6% increase over the
respective previous years. This increase was driven by higher conserver sales and management
expects this trend to continue for the balance of the current fiscal year. Management believes
there may be substantial growth opportunities for the Companys products in a number of foreign
markets and we currently expect 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 67.6% and from 65.6% to 67.2% for
the three and six-month periods ended September 30, 2006, respectively, as compared to the same
periods in the prior year. The increase in cost of sales as a percentage of net sales was a result
of 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 31.6% to 33.8% and from 31.4% to
32.4% as a percentage of net sales for the three and six-month periods ended September 30, 2006, as
compared to the same periods in the prior year. While the
Companys ongoing cost reduction efforts have helped align staffing and operating expenses more
closely with current sales expectations and have decreased actual selling, general, and
administration expendutiers decreases in sales revenues have resulted in selling, general, and
administrative costs increasing as a percentage of net sales. Research and development expenses
decreased by $113,000 and $110,000 for the three and six-month periods ended September 30, 2006,
respectively, as compared to the same periods in the prior year. Currently management expects
research and development expenditures to total approximately $1,500,000 in the fiscal year ending
March 31, 2007, on projects to enhance and expand the Companys product line. During fiscal year
2006, the Company spent $1,574,000 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. At September
30, 2006, the Companys net deferred tax assets related to the California net operating loss
carryforwards expiring in 2007 are offset by a valuation allowance. 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. The Company has California net operating loss carryforwards of $2,679,000 of which
$606,000 expires in 2007 and the remaining balance expires in 2013.
Financial Condition
At September 30, 2006, the Company had cash totaling $1,777,000 or 12.6% of total assets, as
compared to $935,000 (6.5% of total assets) at March 31, 2006. Net working capital decreased from
$9,806,000 at March 31, 2006 to $9,487,000 at September 30, 2006. Net accounts receivable
decreased $652,000 during the six months ended September 30, 2006, due to 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 $78,000. 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 September 30, 2006, the Company has a $790,000
reserve against slow-moving inventories related to the build-up.
The Company depends primarily upon its cash flow from operations to meet its capital
requirements. Notwithstanding the Companys lack of profitability in recent quarters, the Company
generated $1,030,000 of cash from operations in the six-month period ended September 30, 2006.
Historically, the Company has financed its inventory requirements and operating expenses out of
cash flow, and it has not sought to finance its accounts receivable. In December 2005, the Company
entered into a $1 million line of credit agreement. The line of credit was established in order to
fund anticipated capital expenditures. As of September 30, 2006, there were no borrowings under
the line of credit. Advances under the line of credit bear interest at the banks prime rate
(8.25% at
September 30, 2006) and are secured by inventories and accounts receivable. Under the terms
of the credit agreement, the Company is required to maintain a specific working capital, net worth,
profitability levels, and other specific ratios. In addition, if advances were outstanding, the
agreement would prohibit the payment of cash dividends and contains certain restrictions on the
Companys ability to borrow money or purchase assets or interests in other entities without prior
written consent of the bank. At September 30, 2006, the Company was not in compliance with certain
of the covenants related to profitability, is currently negotiating changes to the line of credit
agreement, and may be unable to access the line should it need to. The Company expects capital
expenditures during the next twelve months to be approximately $463,000 and anticipates that cash
flow from operations will be adequate to fund the Companys planned capital expenditures.
The Companys current efforts to expand its product line and enter the sleep disorder market may
require significant cash resources for product development, manufacturing and marketing. The
Company is considering a number of alternative methods to address these needs.
The following table aggregates all of the Companys material contractual obligations as of
September 30, 2006:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 1 |
|
|
1 3 |
|
|
3-5 |
|
|
After 5 |
|
|
|
Total |
|
|
Year |
|
|
Years |
|
|
Years |
|
|
Years |
|
Contractual
Cash Obligations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease
obligations |
|
$ |
847,000 |
|
|
$ |
452,000 |
|
|
$ |
395,000 |
|
|
|
|
|
|
|
|
|
Minimum royalty
obligations |
|
$ |
2,805,000 |
|
|
$ |
523,000 |
|
|
$ |
1,590,000 |
|
|
$ |
632,000 |
|
|
$ |
60,000 |
|
Employee obligations |
|
$ |
400,000 |
|
|
$ |
160,000 |
|
|
$ |
240,000 |
|
|
|
|
|
|
|
|
|
Capital lease
obligations |
|
$ |
7,000 |
|
|
$ |
7,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
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 are
provided for by cash flows generated from operations. Please see Note 8 to the financial
statements in the 2006 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 does not have any outstanding debt and is not subject to any covenants or contractual
restrictions limiting its operations with the exception of those required by its line of credit
agreement indicated above. 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 costs of
good sold, when incurred.
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 November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standard (SFAS) No. 151 (Inventory Costs), an amendment of ARB No. 43, Chapter 4. The
statement clarifies accounting for abnormal amounts of the idle facility expense, freight, handling
costs, and spoilage and requires those items to be expensed when incurred. SFAS 151 is applicable
to inventory costs incurred during fiscal years beginning after June 15, 2005. The Company adopted
SFAS No. 151 on April 1, 2006, and the Company did not incur a significant impact to its financial
statements.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standard (SFAS) No. 123R (Share-Based Payment). SFAS 123R requires the Company to recognize
compensation expense based on the fair value of equity instruments awarded to employees. The
Company adopted SFAS 123R on April 1, 2006, and the Company did not incur a significant impact to
its financial statements.
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 Company is evaluating the
impact of this interpretation and does not anticipate a significant impact to its financial
statements upon implementation.
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 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 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 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. 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 December 31, 2006 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 and therefore does not anticipate a significant impact to its financial
statements upon implementation.
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 September 30, 2006 (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.
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 timely introduce
any new product. 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 unit sales of conservers and therapeutic devices for the
first six months of fiscal 2007 was roughly the same as in fiscal 2006, revenues from the sales of
such products declined by 4%. 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 45% of our sales for the six-months ended September 30, 2006, consistent with the
same period in the prior year. One customer accounted for 38% of net sales for the six-months
ended September 30, 2006 and 2005, respectively. One non-chain customer accounted for 12% of sales
for the six-months ended September 30, 2006. 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.
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 80% 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 will take 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.
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 or and
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 timely deliver 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
The Company held its 2006 Annual Meeting of Shareholders as further discussed below:
|
(a) |
|
The Companys 2006 Annual Meeting of Shareholders was held on October 24,
2006 in Woodland Hills, California. |
|
|
(b) |
|
Proxies for the meeting were solicited pursuant to Regulation 14 under the
Securities Exchange Act of 1934, as amended, there was no solicitation in opposition
to the managements nominees as listed in the proxy statement, and all such nominees
were elected. |
|
|
(c) |
|
At the Annual Meeting, the following matters were considered and voted upon: |
|
(i) |
|
The election of three directors to the Companys board of
directors, which currently consists of seven persons. Only three positions on
the Companys board of directors were to be elected at the Annual Meeting. At
the Annual Meeting, the Companys shareholders elected each of the following
director nominees as directors, to serve on the Companys board of directors
until the Annual Meeting of Shareholders 2007 or until their successors are
duly elected and qualified. The vote of each director was as follows: |
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|
|
Name |
|
For |
|
Against |
|
Withheld |
Thomas E. Jones |
|
|
8,612,270 |
|
|
|
0 |
|
|
|
628,356 |
|
John C. Boyd |
|
|
8,609,820 |
|
|
|
0 |
|
|
|
630,806 |
|
Earl L. Yager |
|
|
8,613,267 |
|
|
|
0 |
|
|
|
627,359 |
|
|
(ii) |
|
To ratify the appointment of KPMG LLP as the Companys independent
auditors for the fiscal year ended March 31, 2007. At the Annual Meeting, the
Companys shareholders approved this proposal by the votes indicated below: |
|
|
|
|
|
|
|
Shares |
For |
|
|
8,774,879 |
|
Against |
|
|
411,988 |
|
Abstain |
|
|
53,759 |
|
(d) None
Item 5. Other Information
None.
Item 6. Exhibits
|
|
|
(a) 31.1
|
|
Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CEO
|
|
|
|
(b) 31.2
|
|
Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CFO |
|
|
|
(c) 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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(d) 99.1
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|
Press release dated November 14, 2006 |
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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. |
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.
(Registrant) |
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Date 11/14/2006
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/s/ Earl L. Yager
Earl L. Yager
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President and Chief Executive Officer |
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Date 11/14/2006
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/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. |
|
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*
|
|
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 November 14, 2006 |
|
|
|
* |
|
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. |