EXHIBIT 13.1
2002 ANNUAL REPORT
TO OUR SHAREHOLDERS
[PHOTOGRAPH]
Letter from the CEO
It is a distinct pleasure to report to you that we have completed the phase
of CHAD's turnaround that has allowed CHAD to return to profitable operations.
For the fiscal year ended March 31, 2002, CHAD was able to generate sales of
$18,730,000, an increase of 54% over the prior year. This resulted in earnings
before income taxes of $167,000, compared with a loss before income taxes of
$3,011,000 for the fiscal year ended March 31, 2001. All of the hardworking
employees of CHAD are gratified and encouraged with these results.
The financial results are largely due to the success of the OXYMATIC(R) 400
series conservers in the marketplace. The increasing rate of sales I mentioned
in last year's Letter from the CEO continued through this year. Our oxygen
conserver line was further expanded with the introduction of the SEQUOIA(TM)
OXYMATIC(R) conservers during the year. The SEQUOIA conservers offer the same
electronic technology found in the OXYMATIC 400 series conservers, but without a
built-in regulator. These new additions enhanced our position as the company
with the widest choice in electronic conservers, another of our stated
objectives last year.
Although the current trend is strong, the market share recovery in the
domestic conserver market may not continue at the same rate in the upcoming
year. We have regained the market leadership position in electronic conservers
and must rely on new products to further CHAD's growth. In this regard, we
continue to work on the development of additional products that we believe will
improve our competitive position.
From an operating standpoint, it is stressful to expand production to support
a 54% sales increase. We were, however, able to more that double our conserver
production level over a short period of time. Our manufacturing team responded
quickly and effectively in attaining the increased production level with a
minimum of disruption and overtime. At the same time, we were able to reduce the
unit cost of our electronic conservers and improve gross profit margins.
Domestic sales of the TOTAL O2(R) Delivery System again increased at a slow
rate over the prior year. However, as we reported in the third quarter, a
customer that represented a large portion of the TOTAL O2 system sales activity
was sold to a national chain. The national chain chose not to continue
purchasing the TOTAL O2 system and the result was a sales reduction of several
hundred thousand dollars per month for this product line. We continue in our
efforts to improve this product's performance. This technology is still viewed
as relatively new in our industry and we believe it can have a significant
future in the home care business and with CHAD.
In the sales area, we added one Regional Sales Manager to assist in the
training, recruitment and general oversight of the manufacturers'
representatives in the field. In addition, Erika Laskey was promoted to Vice
President, Sales and Marketing effective April 1, 2002. Erika and her team have
done an outstanding job over the past year and have played an important role in
the results we have achieved.
On the international front, we were not as successful from a sales
standpoint as we were in the United States. We ended our relationship with our
long time distributors in both Canada and Japan during the 2002 fiscal year.
This caused a reduction in sales for the year in both of these territories from
historic levels. Fortunately, we were able to replace both of these distributors
and believe the new distribution relationships will provide an improved
environment for the sale of CHAD's products in these countries. In addition,
3
TO OUR SHAREHOLDERS
we reorganized ourselves internally to enhance this effort by assigning the
Canada territory to the U.S field organization under Erika Laskey. Oscar
Sanchez, Vice President of Business Development, has taken over the
responsibility for all other international sales.
As we look forward to our plans and strategies for the upcoming year and
beyond, there are several points to mention. First, the CYPRESS(TM)
OXYPneumatic(R) conserver, for which we are awaiting FDA clearance to sell, will
allow us to compete in the pneumatic conserver market, a segment of the
conserver market in which we previously did not have a product offering. We
believe the pneumatic portion of the conserver market represents about 35% of
the total market. The CYPRESS conserver is a state-of-the-art pneumatic
conserver that allows the use of a single lumen cannula and provides an average
savings ratio of greater than 3:1. Most other pneumatic conservers use a dual
lumen cannula, which is more expensive, and provide a savings ratio of only 2:1.
The addition of the CYPRESS conserver will further expand our product offerings
in the conserver field and enhance our competitive position.
Our financial position at year end was strengthened with an income tax refund
of $996,000 that we will receive due to a change in regulations covering net
operating loss carrybacks. This will facilitate our ability to pursue various
opportunities, including the possible acquisition of certain technology and
products that we have been evaluating. Through such an acquisition, we would
seek to add more products to our development pipeline and further broaden our
business base.
In conclusion, I want to thank all of our shareholders for their patience and
confidence during our turnaround. We have made substantial progress in the past
year, yet still have opportunities to expand our product line and improve our
operating results. We see a very exciting future for CHAD. We will all continue
to work diligently to capitalize on those opportunities and enhance the value of
our Company.
Thomas E. Jones
/s/ THOMAS E. JONES
- ----------------------------
Chief Executive Officer
4
SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA YEARS ENDED MARCH 31,
--------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ---------- ---------- ---------- -----------
Net Sales $18,730,000 12,158,000 12,774,000 14,064,000 16,593,000
Interest Income,Net 50,000 87,000 43,000 41,000 164,000
Net Earnings (loss) 1,157,000 (3,011,000) (2,511,000) (1,464,000) 797,000
Basic Earnings (loss) Per Share .12 (.30) (.25) (.15) .08
Diluted Earnings (loss) Per Share .11 (.30) (.25) (.15) .08
Net Working Capital 7,497,000 5,847,000 8,389,000 10,164,000 10,704,000
Total Assets 12,323,000 10,788,000 13,583,000 15,899,000 17,436,000
Shareholders' Equity 10,373,000 9,211,000 12,207,000 14,693,000 16,074,000
No cash dividends have been declared or paid during the periods presented.
5
BALANCE SHEETS
MARCH 31,
-------------------------------
ASSETS 2002 2001
------------ ----------
Current assets:
Cash $ 520,000 1,059,000
Accounts receivable,less allowance for doubtful
accounts of $76,000 and $33,000 in 2002 and 2001, respectively 2,333,000 2,352,000
Income taxes refundable 995,000 --
Inventories (Note 2) 5,284,000 3,415,000
Prepaid expenses 315,000 598,000
------------ ----------
Total current assets 9,447,000 7,424,000
------------ ----------
Property and equipment, at cost:
Office equipment and furniture 1,876,000 1,697,000
Machinery and equipment 905,000 855,000
Tooling 1,377,000 1,223,000
Leasehold improvements 1,814,000 1,801,000
------------ ----------
5,972,000 5,576,000
Less accumulated depreciation and amortization 4,320,000 3,534,000
------------ ----------
Net property and equipment 1,652,000 2,042,000
------------ ----------
Other assets, net (Note 4) 1,224,000 1,322,000
------------ ----------
$ 12,323,000 10,788,000
============ ==========
2002 2001
------------ ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 777,000 465,000
Accrued expenses (Note 7) 1,169,000 1,109,000
Income taxes payable (Note 3) 4,000 3,000
------------ ----------
Total current liabilities 1,950,000 1,577,000
------------ ----------
Commitments (Note 8)
Shareholders' equity (Note 5):
Common shares,no par value
Authorized 40,000,000 shares;
10,059,000 and 10,052,000 shares issued and outstanding 13,097,000 13,092,000
Retained earnings (Accumulated deficit) (2,724,000) (3,881,000)
------------ ----------
Net shareholders' equity 10,373,000 9,211,000
------------ ----------
$ 12,323,000 10,788,000
============ ===========
See accompanying notes to financial statements.
6
STATEMENTS OF OPERATIONS
YEARS ENDED MARCH 31,
--------------------------------------------------
2002 2001 2000
------------ ---------- ----------
Net sales $ 18,730,000 12,158,000 12,774,000
Cost of sales 11,531,000 9,431,000 8,995,000
------------ ---------- ----------
Gross profit 7,199,000 2,727,000 3,779,000
Costs and expenses:
Selling, general and administrative 6,263,000 5,165,000 5,451,000
Research and development 819,000 658,000 560,000
------------ ---------- ----------
Total costs and expenses 7,082,000 5,823,000 6,010,000
------------ ---------- ----------
Operating income (loss) 117,000 (3,096,000) (2,231,000)
Interest income, net 50,000 87,000 43,000
------------ ---------- ----------
Earnings (loss) before income taxes 167,000 (3,009,000) (2,188,000)
Income tax (benefit) expense (Note 3) (990,000) 2,000 323,000
------------ ---------- ----------
Net earnings (loss) $ 1,157,000 (3,011,000) (2,511,000)
============ ========== ==========
Basic earnings (loss) per share $ .12 (.30) (.25)
============ ========== ==========
Diluted earnings (loss) per share $ .11 (.30) (.25)
============ ========== ==========
Weighted shares outstanding:
Basic 10,053,000 10,044,000 10,024,000
Diluted 10,386,000 10,044,000 10,024,000
============ ========== ==========
See accompanying notes to financial statements.
7
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 2002, 2001, AND 2000
COMMON SHARES (NOTE 5) RETAINED EARNINGS
---------------------------- (ACCUMULATED
SHARES AMOUNT DEFICIT)
---------- ----------- -----------------
Balance at March 31, 1999 10,012,000 $13,052,000 $ 1,641,000
Common shares issued in lieu of
cash for directors fees 23,000 25,000 --
Net loss -- -- (2,511,000)
---------- ----------- -----------
Balance at March 31, 2000 10,035,000 13,077,000 (870,000)
Common shares issued in lieu of
cash for directors fees 17,000 15,000 --
Net loss -- -- (3,011,000)
---------- ----------- -----------
Balance at March 31, 2001 10,052,000 13,092,000 (3,881,000)
Exercise of stock options 7,000 5,000 --
Net earnings -- -- 1,157,000
---------- ----------- -----------
Balance at March 31, 2002 10,059,000 $13,097,000 $(2,724,000)
========== =========== ===========
See accompanying notes to financial statements.
8
STATEMENTS OF CASH FLOWS
YEARS ENDED MARCH 31,
-----------------------------------------------
2002 2001 2000
----------- ---------- ----------
Cash flows from operating activities:
Net earnings (loss) $ 1,157,000 (3,011,000) (2,511,000)
Adjustments to reconcile net earnings (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 902,000 909,000 894,000
Loss on disposition of property and equipment -- -- --
Compensation expense related
to option grants and stock issued -- 15,000 25,000
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 19,000 (349,000) 162,000
Decrease (increase) in inventories (1,869,000) 1,882,000 2,345,000
Decrease (increase) in income taxes refundable (995,000) 175,000 512,000
Decrease (increase) in prepaid expenses 283,000 (80,000) (224,000)
Decrease (increase) in deferred income taxes -- -- 445,000
Decrease (increase) in other assets (17,000) (50,000) 90,000
Increase (decrease) in accounts payable 312,000 151,000 87,000
Increase (decrease) in accrued expenses 60,000 47,000 83,000
Increase (decrease) in income taxes payable 1,000 3,000 --
----------- ---------- ----------
Net cash provided by (used in) operating activities (147,000) (308,000) 1,908,000
----------- ---------- ----------
Cash flows from investing activities:
Additions to other assets -- (150,000) (150,000)
Capital expenditures (398,000) (266,000) (123,000)
Dispositions of property and equipment 1,000 11,000 --
----------- ---------- ----------
Net cash used in investing activities (397,000) (405,000) (273,000)
----------- ---------- ----------
Cash flows from financing activities:
Exercise of stock options 5,000 -- --
----------- ---------- ----------
Net cash provided by financing activities 5,000 -- --
----------- ---------- ----------
Net increase (decrease) in cash (539,000) (713,000) 1,635,000
Cash beginning of year 1,059,000 1,772,000 137,000
----------- ---------- ----------
Cash end of year $ 520,000 1,059,000 1,772,000
=========== ========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $ 4,000 -- --
=========== ========== ==========
See accompanying notes to financial statements.
9
NOTES TO FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
CHAD Therapeutics, Inc. (the Company) is in the business of developing,
producing and marketing respiratory care devices designed to improve the
efficiency of oxygen delivery systems for home health care and hospital
treatment of patients suffering from pulmonary diseases.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments approximate fair value as of March
31, 2002 and 2001. The carrying amounts related to cash, accounts receivable,
other current assets, and accounts payable approximate fair value due to the
relatively short maturity of such instruments.
INVENTORIES
Inventories are valued at lower of cost or market. Cost is determined based on
standard cost which approximates the first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation of property and
equipment is provided using the straight-line method based on the estimated
useful lives of the related assets as follows:
Office Equipment and Furniture 5-10 Years
Machinery and Equipment 5-10 Years
Tooling 4 Years
Amortization of leasehold improvements is over the life of the related lease or
asset, whichever is shorter.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the balance sheet date and the reporting of
revenues and expenses during the periods to prepare these financial statements
in conformity with accounting principles generally accepted in the United States
of America. Actual results could differ from those estimates.
Significant estimates include the allowance for doubtful accounts, inventory
valuation, deferred income tax asset valuation allowances, and the estimated
future operating cash flows from the Company's long-lived assets, including its
intangible assets. Considerable management judgement is necessary to estimate
future operating cash flows as future cash flows are impacted by competitive and
other factors that are generally out of management's control. Accordingly,
actual results could vary significantly from management's estimates.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to undiscounted future net cash
flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets.
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment of merchandise.
Allowances for customer returns have not been established as historical
experience has been minor.
COMPREHENSIVE INCOME (LOSS)
The Company did not have components of other comprehensive income during the
periods ended March 31, 2002, 2001 and 2000. As a result, comprehensive income
(loss) is the same as net earnings (loss) for the periods ended March 31, 2002,
2001 and 2000.
ROYALTY EXPENSE
The Company charges royalties paid on product licenses to selling, general and
administrative expenses.
EARNINGS (LOSS) PER COMMON SHARE
Following is a calculation of basic and diluted earnings (loss) per common share
for the years ended March 31, 2002, 2001 and 2000, respectively:
2002 2001 2000
----------- ---------- ----------
Basic earnings per share
Numerator - net earnings (loss) $ 1,157,000 (3,011,000) (2,511,000)
Denominator - common
shares outstanding 10,053,000 10,044,000 10,024,000
----------- ---------- ----------
Basic earnings per share $ .12 (.30) $ (.25)
=========== ========== ==========
Diluted earnings (loss) per share
Numerator - net earnings (loss) $ 1,157,000 (3,011,000) (2,511,000)
Denominator -
Common shares outstanding 10,053,000 10,044,000 10,024,000
Common stock options 333,000 -- --
----------- ---------- ----------
10,386,000 10,044,000 10,024,000
----------- ---------- ----------
Diluted earnings (loss) per share $ .11 (.30) $ (.25)
=========== ========== ==========
Options to purchase 438,717, 1,010,000, and 979,000 shares of common stock at
prices ranging from $3.75 to $12,54, $.50 to $12.54, and from $.88 to $12.54 per
share were not included in the computation of diluted earnings per share in
2002, 2001, and 2000, respectively, because their inclusion would be
anti-dilutive.
10
NOTES TO FINANCIAL STATEMENTS
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and net operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
MAJOR CUSTOMER
No one customer exceeded 10% of net sales during 2001 or 2000. One national
chain customer accounted for 20% of net sales during 2002. The Company's
customers are affected by Medicare reimbursement policy as approximately 80% of
home oxygen patients are covered by Medicare and other government programs.
STOCK OPTION PLAN
The Company accounts for its stock option plan in accordance with the provisions
of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. The Company has also adopted the pro
forma disclosure provisions of Statement of Financial Accounting Standards
(SFAS) No. 123, Accounting for Stock-Based Compensation, which permits entities
to provide pro forma net income and pro forma net earnings per share disclosures
as if the fair-value-based method defined in SFAS No. 123 had been applied.
SEGMENT INFORMATION
The Company operates in one segment, the respiratory care market.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year's balances to conform
to the 2002 presentation.
(2) INVENTORIES
At March 31, 2002 and 2001, inventories consisted of the following:
2002 2001
---------- ---------
Finished goods $ 935,000 930,000
Work in process 987,000 594,000
Raw materials
and supplies 3,362,000 1,891,000
---------- ---------
$5,284,000 3,415,000
========== =========
During the years ended March 31, 2001 and 2000, the Company recorded inventory
write-downs totaling $112,000 and $294,000, respectively.
(3) INCOME TAXES
The provision (benefit) for income taxes for fiscal 2002, 2001, and 2000
consisted of the following:
2002 2001 2000
--------- -------- --------
Current:
Federal $(995,000) -- (123,000)
State 5,000 2,000 1,000
--------- -------- --------
5,000 2,000 (122,000)
Deferred:
Federal (6,000) -- 231,000
State 6,000 -- 214,000
--------- -------- --------
-- -- 445,000
--------- -------- --------
Total $(990,000) 2,000 323,000
========= ======== ========
A reconciliation of the difference between the Company's provision (benefit) for
income taxes and the statutory income tax for the years ended March 31, 2002,
2001 and 2000, respectively, is as follows:
2002 2001 2000
----------- ---------- ---------
Statutory tax
expense (benefit) $ 57,000 (1,023,000) (744,000)
State income tax, net 6,000 (84,000) (91,000)
Valuation allowance (1,030,000) 1,109,000 1,151,000
Warranty and other (23,000) -- 10,000
Tax credits, net -- -- (3,000)
----------- ---------- ---------
$ (990,000) 2,000 323,000
=========== ========== =========
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at March 31, 2002 and 2001 are presented as follows:
2002 2001
----------- ----------
Bad debt reserves $ 32,000 14,000
Accrued expenses 284,000 322,000
Inventories 106,000 287,000
Depreciation 256,000 111,000
Amortization 21,000 --
Net Operating Loss 599,000 1,640,000
Tax Credits 97,000 46,000
----------- ----------
Total deferred tax assets 1,395,000 2,420,000
Deferred tax liabilities:
State Taxes (165,000) (160,000)
----------- ----------
Subtotal 1,230,000 2,260,000
Valuation Allowance (1,230,000) (2,260,000)
----------- ----------
Net deferred tax assets $ -- --
=========== ==========
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all
11
NOTES TO FINANCIAL STATEMENTS
of the deferred tax assets will be realized. At March 31, 2002, the Company's
net deferred tax assets are fully 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 Federal and California net operating loss carry forwards of $1,003,000 and
$3,178,000, respectively. The Federal and California net operating losses expire
in 2021 and 2006, respectively. In addition, the Company has manufacturing tax
credit carryforwards of $97,000 available to offset future California taxable
income.
(4) OTHER ASSETS
Other assets include amounts paid for a license on new and existing products.
The license fee is being amortized using the straight-line method over the life
of the related patents, 14 years. Accumulated amortization on the license fee
amounted to $422,000 and $307,000 at March 31, 2002 and 2001, respectively. Net
intangible assets were $1,196,000 and $1,214,000 at March 31, 2002 and 2001,
respectively.
(5) SHAREHOLDERS' EQUITY
In 1999 the Company purchased its own stock for purposes of funding
contributions to the Company's 401(k) plan. Periodically as common shares were
sold to the plan, the difference between the cost and market value at the date
of transfer was charged or credited to shareholders' equity.
The Company has an incentive stock option plan (the Plan) for key employees as
defined under Section 422(A) of the Internal Revenue Code. The Plan as amended,
provides that 1,509,000 common shares be reserved for issuance under the Plan,
which expires on September 10, 2004. In addition, the Plan provides that
non-qualified options can be granted to directors and independent contractors of
the Company. Transactions involving the stock option plan are summarized as
follows:
WEIGHTED
AVERAGE
OPTION OPTION PRICE
SHARES AMOUNT PER SHARE
---------- ----------- ----------
Incentive Options:
Outstanding --
March 31, 1999 880,000 $ 4,886,000 5.55
Cancelled (261,000) (1,510,000) 5.79
Granted 204,000 216,000 1.06
-------- ----------- ----
Outstanding --
March 31, 2000 823,000 3,592,000 4.36
Cancelled (228,000) (1,121,000) 4.92
Granted 244,000 227,000 0.93
-------- ----------- ----
Outstanding --
March 31, 2001 839,000 2,698,000 3.22
Cancelled (25,000) (80,000) 3.20
Granted 75,000 253,000 3.37
Exercised (7,000) (5,000) .71
-------- ----------- ----
Outstanding --
March 31, 2002 882,000 $ 2,866,000 3.25
======== =========== ====
Exercisable --
March 31, 2002 548,000 $ 2,135,000 4.76
======== =========== ====
Non-qualified Options:
Outstanding --
March 31, 1999 165,000 $ 1,490,000 9.03
Cancelled (25,000) (96,000) 3.84
Granted 16,000 35,000 2.19
-------- ----------- ----
Outstanding --
March 31, 2000 156,000 1,429,000 9.16
Cancelled (16,000) (64,000) 4.00
Granted 31,000 43,000 1.39
-------- ----------- ----
Outstanding --
March 31, 2001 171,000 1,408,000 8.23
Granted 19,000 19,000 1.00
-------- ----------- ----
Outstanding --
March 31, 2002 190,000 $ 1,427,000 7.50
======== =========== ====
Exercisable --
March 31, 2002 156,000 $ 1,391,000 8.92
======== =========== ====
At March 31, 2002, information regarding outstanding options is summarized as
follows:
RANGE OF EXERCISE PRICES
-------------------------------
$ .50-6.69 7.63-12.54
---------- ----------
Number outstanding 849,000 223,000
Weighted average
remaining life (yrs.) 7.5 4.1
Weighted average
exercise price $ 2.30 10.49
Number exercisable 502,000 201,000
Weighted average
exercise price $ 2.79 10.57
Incentive and non-qualified options were granted at prices not less than 100% of
market value at dates of grant. Options under the Plan become exercisable on the
anniversary of the grant date on a prorata basis over a defined period and
expire 10 years after the date of grant. To the extent the Company derives a tax
benefit from options exercised by employees, such benefit is credited to Common
Shares when realized on the Company's income tax returns.
The Company applies Accounting Principles Board Opinion No. 25 in accounting for
the Plan and no compensation expense has been recognized for its stock options
in the accompanying financial statements. Had compensation cost for awards under
the Company's stock option plan been determined based upon the fair value of the
option at the grant date as prescribed under Statement of Financial Accounting
Standards No. 123, the Company's net earnings (loss) in 2002, 2001 and 2000
would have been reduced (increased) by approximately $169,000, $(172,000), and
$(266,000), respectively, and earnings (loss) per share would have been reduced
(increased) by $.02, $(.02), and $(.03) per share in 2002, 2001 and 2000,
respectively. The weighted average fair value of options granted during 2002,
2001 and 2000 is estimated at $2.04, $.51, and $.75, respectively. The
disclosure of compensation cost under this pronouncement may not
12
NOTES TO FINANCIAL STATEMENTS
be representative of the effects on net earnings (loss) for future years. The
fair value of options granted during each period was estimated using the
Black-Scholes option pricing model with the following assumptions:
2002 2001 2000
----- ---- -----
Risk-free interest rate 5.9% 5.9% 5.9%
Forfeiture rate 2.0% 2.0% 2.0%
Dividend yield .0 .0 .0
Volatility 89% 90% 82%
Expected life (years) 5.0 5.0 5.0
(6) EMPLOYEE BENEFIT PLAN
In December, 1992, the Company adopted a defined contribution profit sharing
plan, including features under Section 401(k) of the Internal Revenue Code. The
purpose of the plan is to provide an incentive for employees to make regular
savings for their retirement. Company contributions to the profit sharing plan
are discretionary and are determined by the Board of Directors. There were no
contributions in 2002, 2001 and 2000.
(7) ACCRUED EXPENSES
Accrued expenses consist of the following:
2002 2001
---------- ---------
Accrued royalties $ 460,000 431,000
Product and business
liability insurance 77,000 48,000
Deferred rent 22,000 39,000
Accrued vacation 133,000 110,000
Warranty Expense 161,000 134,000
Retirement liability 73,000 142,000
Other 243,000 205,000
---------- ---------
$1,169,000 1,109,000
========== =========
At March 31, 2002, the Company had an obligation to pay its founder and former
Chief Executive Officer $75,000 per year in retirement pay for the year ending
March 31, 2003. The retirement liability represents the net present value of
this obligation.
(8) COMMITMENTS
The Company is currently leasing its administrative and plant facilities and
certain office equipment under noncancelable operating leases which expire
through June, 2007.
The Company's minimum annual rental commitments under these leases are as
follows:
2003 $382,000
2004 106,000
2005 5,000
2006 5,000
2007 2,000
--------
TOTAL: $500,000
========
Rent expense amounted to $470,000, $431,000, and $430,000 for the years ended
March 31, 2002, 2001 and 2000, respectively.
The Company is involved in certain legal actions resulting from the ordinary
course of business. The Company believes the ultimate outcome of the legal
actions will not have a material adverse impact on the Company's financial
position.
(9) GEOGRAPHIC INFORMATION
The Company has one reportable operating segment as defined in Note 1.
Geographic information regarding the Company's net sales is as follows:
2002 2001 2000
----------- ---------- ----------
United States $17,628,000 10,126,000 11,508,000
Germany 289,000 751,000 40,000
All other countries 813,000 1,281,000 1,226,000
----------- ---------- ----------
$18,730,000 12,158,000 12,774,000
=========== ========== ==========
All long-lived assets are located in the United States.
Sales of OXYMATIC(R) conservers and OXYLITE(R) systems accounted for 60%, 42%,
and 56% of the Company's net sales for the years ended March 31, 2002, 2001 and
2000, respectively.
(10) VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
The following is the Company's schedule of activity in the valuation and
qualifying accounts and reserves for the years ended March 31, 2002, 2001 and
2000:
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
OF YEAR EXPENSES DEDUCTIONS OF YEAR
--------- ---------- ---------- -------
ALLOWANCE FOR
DOUBTFUL ACCOUNTS:
2000 88,000 59,000 52,000 95,000
2001 95,000 70,000 132,000 33,000
2002 33,000 64,000 21,000 76,000
(11) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table presents summarized unaudited quarterly financial data for
2002 and 2001:
BASIC &
DILUTED
NET EARNINGS
GROSS EARNINGS (LOSS)
REVENUE PROFIT (LOSS) PER SHARE
----------- ---------- ----------- ---------
2002
First Quarter $ 4,847,000 $1,726,000 $ 13,000 $0.00
Second Quarter 5,106,000 1,872,000 67,000 0.01
Third Quarter 4,669,000 1,852,000 81,000 0.01
Fourth Quarter 4,108,000 1,749,000 996,000 $0.10
----------- ---------- ---------- -----
Year $18,730,000 $7,199,000 $1,157,000 $0.12
=========== ========== ========== =====
13
NOTES TO FINANCIAL STATEMENTS
BASIC &
DILUTED
NET EARNINGS
GROSS EARNINGS (LOSS)
REVENUE PROFIT (LOSS) PER SHARE
----------- ---------- ----------- ---------
2001
First Quarter $ 2,965,000 $ 691,000 $ (720,000) $(0.07)
Second Quarter 3,134,000 735,000 (685,000) (0.07)
Third Quarter 2,757,000 549,000 (856,000) (0.09)
Fourth Quarter 3,302,000 752,000 (750,000) (0.07)
----------- ---------- ---------- -----
Year $12,158,000 $2,727,000 $(3,011,000) $(0.30)
=========== ========== ========== =====
In the fourth quarter of 2002, the Company recorded an income tax benefit of
$995,000 that resulted from recently enacted federal income tax regulations
extending the carryback periods for operating losses incurred in 2002 and 2001.
(12) NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 141, Business Combinations (SFAS No. 141)
and SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). SFAS No.
141 requires that the purchase method of accounting be used for all business
combinations. SFAS_No. 141 specifies criteria that intangible assets acquired in
a business combination must meet to be recognized and reported separately from
goodwill. SFAS No. 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but, instead, tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 also requires that intangible assets with estimable useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with SFAS No. 121 and
subsequently, SFAS No. 144 after its adoption.
The Company adopted the provision of SFAS No. 141 as of July 1, 2001, and SFAS
No. 142 was effective April 1, 2002. The Company does not have any assets
affected by SFAS No. 141 and is already compliant with SFAS No. 142.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations (SFAS No. 143). SFAS No. 143 requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligation associated with the retirement of tangible long-lived
assets that result from the acquisition, construction, development and/or normal
use of the assets. The Company is required to adopt SFAS No. 143 on April 1,
2003. The Company does not currently have any assets affected by SFAS No. 143.
In August, 2001, the FSB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets (SFAS No. 144). This Statement requires that
long-lived assets be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If the carrying amount of an asset exceeds its
estimated future cash flows, an impairment charge is recognized by the amount by
which the carrying amount of the asset exceeds the fair value of the asset. SFAS
No. 144 requires companies to separately report discontinued operations and
extends that reporting to a component of an entity that either has been disposed
of (by sale, abandonment, or in a distribution to owners) or is classified as
held for sale. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell. The Company adopted SFAS No.
144 on April 1, 2002, and it did not have an impact on the Company's financial
statements.
SFAS NO. 145
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
which requires that the extinguishment of debt not be considered an
extraordinary item under APB Opinion No. 30, Reporting the Results of Operations
- - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,
unless the debt extinguishment meets the unusual in nature and infrequency of
occurrence criteria in APB 30. SFAS No. 145 is effective for fiscal years
beginning after May 15, 2002. The adoption of SFAS No. 145 is not expected to
have a material impact on the Company's financial condition or results of
operations.
14
INDEPENDENT AUDITORS REPORT
THE BOARD OF DIRECTORS
AND SHAREHOLDERS
CHAD Therapeutics, Inc.
We have audited the accompanying balance sheets of CHAD Therapeutics, Inc. as of
March 31, 2002 and 2001 and the related statements of operations, shareholders'
equity and cash flows for each of the years in the three year period ended March
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CHAD Therapeutics, Inc. as of
March 31, 2002 and 2001 and the results of its operations and its cash flows for
each of the years in the three year period ended March 31, 2002, in conformity
with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Los Angeles, California
May 8, 2002
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
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 significantly affected during the past several years 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, contributed to an erosion of the Company's market
share from 1998 through the fiscal year ended March 31, 2001, as devices that
were less expensive but which provide lower oxygen savings (or, in some cases,
do not truly provide ambulatory oxygen) prospered in this environment. The
Company's market share for conservers had also been affected by the introduction
of competing devices that offered features not available on the OXYMATIC 301,
which was the Company's primary product in this market until July of 2000.
In 1998 the Company introduced the TOTAL O2 Delivery System, which combines the
benefits of an oxygen concentrator with a system enabling patients to refill
their portable cylinders. Initial sales of the TOTAL O2 system by home oxygen
dealers were slowed by several factors discussed below.
In order to address this situation, the Company implemented a four-part
strategy:
- - Introduction of the OXYMATIC 400 series in July 2000 with improved
features, which place these oxygen conservers at the forefront of the
industry;
- - Development of additional oxygen conserver models that will diversify
the product line in order to offer customers a range of oxygen
conservation choices;
- - A continued promotional and educational campaign with respect to the
benefits of the TOTAL O2 system, coupled with greater focus on
monitoring the performance of component suppliers; and
- - Cost cutting to align the Company's operating expenses more closely with
its revenue profile.
While these measures have had a positive impact and management believes they
should continue to enhance the Company's competitive position and future
operating performance, no assurances can be given that these objectives will be
achieved. Management of the Company will continually monitor the success of
these efforts and will attempt to remain flexible in order to adjust to possible
future changes in the market for oxygen conserving devices.
RESULTS OF OPERATIONS
Sales for the years ended March 31, 2002 and 2001, increased $6,572,000 (54.1%)
and decreased $616,000 (4.8%), respectively, as compared to the prior years. The
decrease in sales in 2001 related primarily to price reductions and lower
domestic unit sales of OXYMATIC conservers and OXYLITE complete portable oxygen
systems which were being affected by the marketing environment for home oxygen
therapy discussed below. The increase in sales in 2002 is a result of sales of
the new OXYMATIC 400 series conservers. Domestic unit sales of conservers for
the year ended March 31, 2002, increased 155% as compared to a dollar increase
of 126% due to price reductions and the effects of national chain contract
pricing (see below).
Sales to foreign distributors represented 6%, 17% and 10% of total sales for the
years ended March 31, 2002, 2001 and 2000, respectively. Currently, management
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.
The current procedures for reimbursement by Medicare for home oxygen services
provide a prospective flat fee monthly payment based solely on the patient's
prescribed oxygen requirement. Under this system, inexpensive concentrators have
grown in popularity because of low cost and less frequent servicing
requirements. At the same time, interest heightened in oxygen conserving
devices, such as the Company's products, which can extend the life of oxygen
supplies and reduce service calls by dealers, thereby providing improved
mobility for the patient and cost savings for dealers. In January of 1998 and
1999, the Federal government implemented reimbursement cuts of 25% and 5%,
respectively. These cuts affected homecare providers' purchasing patterns as
they struggled to deal with significant reductions in their revenues.
In addition, other changes in the health care delivery system, including the
increase in the acceptance and utilization of managed care, have stimulated a
significant consolidation among home oxygen dealers. As major national and
regional home medical equipment chains attempt to secure managed care contracts
and improve their market position, they have expanded their distribution
networks through the acquisition of independent dealers in strategic areas.
Three major national chains accounted for approximately 35%, 18% and 20% of the
Company's domestic sales for the years ended March 31, 2002, 2001 and 2000,
respectively, with one chain accounting for 20% of sales for the year ended
March 31, 2002. Margins on these sales are generally lower due to quantity
pricing and consolidation has, in certain instances, resulted in reduced
purchases as the former independent provider complies with the chain's
purchasing policies. To ensure continued awareness of the benefits of the
Company's products by chain headquarters' personnel, a proactive marketing and
communication program is in effect with all of the major national chains. As
stated above, the
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Company believes that its revenues during the three years ending March 31, 2001,
were adversely affected by several factors. These include price competition,
continuing industry consolidation and competitive products with features not
found in the Company's products prior to the introduction of the OM-400 series
conservers discussed below. The effects of managed care and concerns over the
severity of reimbursement cuts have, in many cases, resulted in the provision of
systems to patients that do not provide truly ambulatory oxygen. Management
believes these factors may continue to affect the Company's revenues from sales
of oxygen conserving devices for the foreseeable future. To combat the erosion
in sales of the oxygen conserver product line, the Company is developing and
introducing several new products in this area. The first of these, the OXYMATIC
401 conserver, received 501(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 most recent was
the introduction of the Sequoia OXYMATIC 300 series conservers, which the
Company began shipping in December 2001. 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 over the prior three years. No
estimate can currently be made regarding the level of success the Company may
achieve with the OXYMATIC 400 series conservers. For information, which may
affect the forward-looking statements made in this paragraph about the OXYMATIC
400 series conservers, see Outlook: Issues and Risks -- New Products.
Management also believes that, based on its experience in the home oxygen
industry, future revenues may be positively affected by sales of the TOTAL O2
Delivery System. The TOTAL O2 system provides stationary oxygen for patients at
home, portable oxygen, including an oxygen conserving device for ambulation and
a safe and efficient mechanism for filling portable oxygen cylinders. This
should provide home care dealers with means to deal with the reimbursement cuts
discussed above by reducing their monthly cost of servicing patients while at
the same time providing a higher quality of service by maximizing ambulatory
capability. The Company received clearance in November 1997, to sell this
product from the Food and Drug Administration. Initial sales of the TOTAL O2
system were adversely affected by several factors, including the overall home
oxygen market climate as well as start-up manufacturing and related supplier
quality issues. The Company has taken a number of steps to resolve the
manufacturing and supplier issues, however, further progress in this regard will
be required before the TOTAL O2 system can realize its full market potential. In
October 2001 a customer that was purchasing significant numbers of TOTAL O2
systems was acquired by a national chain that has discontinued those purchases.
No estimates can currently be made regarding the level of success the Company
may achieve with the TOTAL O2 system. For information that may affect the
outcome of forward-looking statements made in this paragraph about the TOTAL O2
systems, see Outlook: Issues and Risks -- New Products.
Cost of sales as a percent of net sales decreased from 77.6% to 61.9% and
increased from 70.4% to 77.6% for the two years ended March 31, 2002 and 2001,
respectively, as compared to the prior year's periods. The year ended March 31,
2002, was primarily affected by increased sales volume while the corresponding
prior year was affected by decreased sales volume and the corresponding impact
of fixed overhead costs on units produced, price competition and the lower gross
profit margin on the TOTAL O2 system.
Selling, general and administrative expenditures increased from $5,165,000 (42%
of sales) to $6,263,000 (33% of sales) and decreased from $5,451,000 (43% of
sales) to $5,165,000 (42% of sales) for the years ended March 31, 2002 and 2001,
respectively. The increase in 2002 is primarily the result of variable selling
expenses that fluctuate directly with sales volume. The Company's cost reduction
efforts over the past two years, including reductions in personnel, should align
staffing and operating expenses more closely with current sales expectations,
but will be offset to some extent by commissions paid to the Company's field
sales force of manufacturer's representatives. Research and development expenses
increased by $161,000 and $98,000 for the years ended March 31, 2002 and 2001,
as compared to the prior years. Currently, management expects research and
development expenditures to total approximately $1,000,000 in the fiscal year
ended March 31, 2003, on projects to enhance and expand the Company's product
line. Interest income decreased $37,000 for the year ended March 31, 2002, as
compared to the prior year due to generally lower cash balances than in the
prior year and lower interest rates in the current year.
At March 31, 2002, the Company had fully utilized its net operating loss
carrybacks and had approximately $1,003,000 and $3,178,000 in Federal and
California net operating loss carryforwards, respectively. As a result of
valuation allowances placed on the net operating loss carryforwards and deferred
tax assets, these net operating loss carryforwards and deferred tax assets will
be available to offset future income tax expense when and if the Company
generates taxable income. In the fourth quarter of 2002, the Company recorded an
income tax benefit of $995,000 that resulted from recently enacted federal
income tax regulations extending the carryback periods for operating losses
incurred in 2002 and 2001.
FINANCIAL CONDITION
At March 31, 2002, the Company had cash totaling $520,000 or 5% of total assets,
as compared to $1,059,000 (10% of total assets) at March 31, 2001. Networking
capital increased from $5,847,000 at March 31, 2001 to $6,501,000 at March 31,
2002. Accounts receivable decreased $19,000 during the year ended March 31,
2002, due to the decrease in foreign sales. Future increases or decreases in
accounts
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
receivable will generally coincide with sales volume fluctuations and the timing
of shipments to foreign customers. During the same period, inventories increased
$1,869,000. This increase relates primarily to purchase of raw materials to keep
up with increasing sales demand. The Company attempts to maintain sufficient
inventories to meet its customer needs as orders are received. Thus, future
inventory and related accounts payable levels will be impacted by the ability of
the Company to maintain its safety stock levels. If safety stock levels drop
below target amounts, then inventories in subsequent periods will increase more
rapidly as inventory balances are replenished. Currently, inventory balances are
generally near safety stock levels.
Management believes cash balances and funds derived from operations should be
adequate to meet the Company's cash requirements for the next twelve months
given the recent recovery of market share for oxygen conservers. Cash derived
from operations will depend on the ability of the Company to maintain profitable
operations and the timing of increases in receivables and inventories. If
profitable operations do not continue, the Company may need to seek other
sources of working capital but currently has no such arrangements in place and
no assurances can be given that if and when needed other sources of working
capital would be available. The Company expects capital expenditures during the
next twelve months to be approximately $300,000.
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.
SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 Company's 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 writes down inventories for excess and slow moving
items. The amount of the write down is based on an analysis of inventory
turnover for individual items in inventory. A write down is recorded for items
that management believes cannot be sold above cost. 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. Recoverability is
based on management's estimate of future cash flows to be generated by that
asset. Such estimated cash flows are impacted by competitive and other factors
that are generally out of management's control. If an asset is considered
impaired, the asset is written down by 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 Company's reported results is dependent on each asset's 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
Company's ability to generate future taxable income.
OUTLOOK: ISSUES & RISKS
This annual report contains forward-looking statements, which reflect the
Company's current views with respect to future events and financial performance.
These forward-looking statements are subject to certain risks and uncertainties,
which may cause actual operating results to differ materially from currently,
anticipated results. Among the factors that could cause actual results to differ
materially are the following:
DEPENDENCE UPON A SINGLE PRODUCT LINE
Although the Company currently markets a number of products, these products
comprise a single product line for patients requiring supplementary oxygen. The
Company's future performance is thus dependent upon developments affecting this
segment of the health care market and the Company's ability to remain
competitive within this market sector.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
NEW PRODUCTS
The Company's future growth in the near term will depend in significant part
upon its ability to successfully introduce new products. In recent years, the
Company has introduced the OXYMATIC 400 series conservers, the TOTAL O2 Delivery
System and the Company is currently developing additional new products. The
success of these products will depend upon the health care community's
perception of such products capabilities, clinical efficacy and benefit to
patients and obtaining timely regulatory approval. In addition, prospective
sales will be impacted by the degree of acceptance achieved among home oxygen
dealers and patients requiring supplementary oxygen. As with any product, the
Company's ability to successfully promote the OXYMATIC 400 series conservers,
the TOTAL O2 Delivery System and other products cannot be assessed at this time.
CONSOLIDATION OF HOME CARE INDUSTRY
The home health care industry is undergoing significant consolidation. As a
result, the market for the Company's products is increasingly influenced by
major national chains. Three major national chains accounted for 35% of the
Company's domestic sales during the year ended March 31, 2002. Future sales may
be increasingly dependent on a limited number of customers, which may have an
impact on margins due to quantity pricing.
COMPETITION
Chad's success in the early 1990's has drawn new competition to vie for a share
of the home oxygen market. These new competitors include both small and very
large companies. While the Company believes the quality of its products and its
established reputation will continue to be a competitive advantage, some
competitors have successfully introduced lower priced products with features not
previously found in the Company's products but which do not provide oxygen
conserving capabilities comparable to the Company's products. Most of these
competitors have greater capital resources than the Company. No assurance can be
given that increased competition in the home oxygen market will not continue to
have an adverse affect on the Company's operations.
RAPID TECHNOLOGICAL CHANGE
The health care industry is characterized by rapid technological change. The
Company's products may become obsolete as a result of new developments. The
Company's ability to remain competitive will depend to a large extent upon its
ability to anticipate and stay abreast of new technological developments related
to oxygen therapy. The Company has limited internal research and development
capabilities. Historically, the Company has contracted with outside parties to
develop new products. Some of the Company's competitors have substantially
greater funds and facilities to pursue research and development of new products
and technologies for oxygen therapy.
POTENTIAL CHANGES IN ADMINISTRATION OF HEALTH CARE
A number of bills proposing to regulate, control or alter the method of
financing health care costs have been discussed and certain of such bills have
been introduced in Congress and various state legislatures. Because of the
uncertain state of health care proposals, it is not meaningful at this time to
predict the effect on the Company if any of these proposals is enacted.
Approximately 80% of home oxygen patients are covered by Medicare and other
government programs. Federal law has altered the payment rates available to
providers of Medicare services in various ways during the last several years.
Congress has passed legislation, which has reduced Medicare spending. It cannot
yet be predicted how future changes in reimbursement levels will affect the home
oxygen industry and there can be no assurance that such changes will not have an
adverse effect on the Company's business.
PROTECTION OF INTELLECTUAL PROPERTY RIGHTS
The Company pursues a policy of protecting its intellectual property rights
through a combination of patents, trademarks, trade secret laws and
confidentiality agreements. The Company considers the protection of its
proprietary rights and the patentability of its products to be significant to
the success of the Company. To the extent that the products to be marketed by
the Company do not receive patent protection, competitors may be able to
manufacture and market substantially similar products. Such competition or
claims that the Company's products infringe the patent rights of others could
have an adverse impact upon the Company's business.
PRODUCT LIABILITY
The nature of the Company's business subjects it to potential legal actions
asserting that the Company is liable for damages for product liability claims.
Although the Company maintains product liability insurance in an amount which it
believes to be customary in the industry, there is no assurance that this
insurance will be sufficient to cover the costs of defense or judgments which
might be entered against the Company. The type and frequency of these claims
could have an adverse impact on the Company's results of operations and
financial position.
AVAILABILITY AND RELIABILITY OF THIRD PARTY COMPONENT PRODUCTS
The Company tests and packages its products in its own facility. Some of its
other manufacturing processes are
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
conducted by other firms and the Company expects to continue using outside firms
for certain manufacturing processes for the foreseeable future and is thus
dependent on the reliability and quality of parts supplied by these firms.
The Company's agreements with its suppliers are terminable at will or by notice.
The Company believes that other suppliers would be available in the event of
termination of these arrangements. No assurance can be given, however, that the
Company will not suffer a material disruption in the supply of its products.
ACCOUNTING STANDARDS
Accounting standards promulgated by the Financial Accounting Standards Board
change periodically. Changes in such standards may have an impact on the
Company's future financial position. In July 2001, the Financial Accounting
Standards Board issued FASB Statement No. 142, Accounting for Goodwill and Other
Intangible Assets. Statement 142 will require that intangible assets with
estimable useful lives be amortized over their respective useful lives to their
estimated residual values and reviewed for impairment in accordance with FAS
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, or, upon adoption of FASB Statement No. 144
(see below). The Company is required to adopt the provisions of Statement 142
effective April 1, 2002. The adoption of Statement 142 is not expected to have a
material impact on the financial statements of the Company.
In October 2001, the Financial Accounting Standards Board issued FASB Statement
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. While Statement No. 144 supersedes FASB Statement No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of, it retains many of the fundamental provisions of that Statement.
The Company is required to adopt the provisions of Statement 144 effective April
1, 2002. The adoption of Statement 144 is not expected to have a material impact
on the financial statements of the Company.
ADDITIONAL RISK FACTORS
Additional factors, which might affect the Company's performance, may be listed
from time to time in the reports filed by the Company with the Securities and
Exchange Commission.
20
CORPORATE DATA
OFFICERS
THOMAS E. JONES
Chief Executive Officer
and President
EARL L. YAGER
Chief Operating Officer,
Executive Vice President,
Chief Financial Officer and Secretary
OSCAR J. SANCHEZ
Vice President, Business Development
ALFONSO DEL TORO
Vice President, Manufacturing
KEVIN McCULLOH
Vice President, Engineering
ERIKA LASKEY
Vice President, Sales and Marketing
DIRECTORS
THOMAS E. JONES
Chief Executive Officer & President
CHAD Therapeutics, Inc.
EARL L. YAGER
Chief Operating Officer
CHAD Therapeutics, Inc.
DAVID L. CUTTER
Retired Chairman Of The Board
Cutter Laboratories, Inc.
NORMAN COOPER
Retired Chairman
Kallir, Philips, Ross, Inc.
JOHN C. BOYD
Retired
PHILIP T. WOLFSTEIN
President
Wolfstein International, Inc.
JAMES M. BROPHY
President
Missouri Baptist Medical Center
CORPORATE DATA
CORPORATE HEADQUARTERS
21622 Plummer Street
Chatsworth, CA 91311
(818) 882-0883
LEGAL COUNSEL
Square, Sanders & Dempsey LLP
AUDITORS
KPMG LLP
Los Angeles, California
TRANSFER AGENT AND REGISTRAR
American Stock Transfer Company
40 Wall Street
New York, NY 10005
COMMON STOCK PRICE RANGE
Beginning August 3, 1993, the Company's common shares were traded on the
American Stock Exchange Emerging Company Marketplace and on June 6, 1994, the
Company's shares moved to the primary list of the American Stock Exchange with
the symbol CTU. The following table sets forth, for the periods indicated, the
high and low closing prices as furnished by the American Stock Exchange.
QUARTER ENDED HIGH LOW
------------------- ---- ---
June 30, 2000 ................. 1.88 .81
September 30, 2000 ............ 1.69 1.00
December 31, 2000 ............. 1.06 .50
March 31, 2001 ................ 1.14 .50
June 30, 2001 ................. 2.83 .75
September 30, 2001 ............ 3.50 1.94
December 31, 2001 ............. 3.25 2.76
March 31, 2002 ................ 4.17 2.70
As of June 12, 2002, there were approximately 258 shareholders of record and
approximately 3,800 beneficial owners of the Company's common stock. No cash
dividends have been paid on the common stock.
SEC FORM 10-K
A copy of the Company's annual report to the Securities and Exchange Commission
on Form 10-K is available without charge upon written request to:
Chief Financial Officer
CHAD Therapeutics, Inc.
21622 Plummer Street
Chatsworth, CA 91311
21
[2001 ANNUAL REPORT BACK COVER PAGE]
Visit us on the web at:
www.chadtherapeutics, com
CHAD
THERAPEUTICS
21622 Plummer Street
Chatsworth, CA 91311
Phone: 818.882.0883
Toll Free: 800.423.8870
Fax: 818.889.1809