-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LgQZJAl4sY+rpE3hwVAJWREUKoVp5f4spQHuvgJz5B+8WVBTK+VyF9Ijvh1EdwPU pwQnBmceGrCoeOIG5Kn6Ig== 0000950148-98-001564.txt : 19980622 0000950148-98-001564.hdr.sgml : 19980622 ACCESSION NUMBER: 0000950148-98-001564 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980619 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHAD THERAPEUTICS INC CENTRAL INDEX KEY: 0000713492 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 953792700 STATE OF INCORPORATION: CA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12214 FILM NUMBER: 98651350 BUSINESS ADDRESS: STREET 1: 21622 PLUMMER STREET CITY: CHATSWORTH STATE: CA ZIP: 91311 BUSINESS PHONE: 818-882-0883 MAIL ADDRESS: STREET 1: 21622 PLUMMER STREET CITY: CHATSWORTH STATE: CA ZIP: 91311 10-K 1 FORM 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 F O R M 10 - K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) For the fiscal year ended March 31, 1998 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (No Fee Required) For the transition period from __________ to __________ Commission file number 0-11363 Chad Therapeutics, Inc. (Exact name of registrant as specified in its charter) California 95-3792700 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 21622 Plummer Street, Chatsworth, CA 91311 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (818) 882-0883 Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Shares, $.01 par value (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x_ No __ Indicate by check mark if disclosures of delinquent filers pursuant to Item 405 of Regulation SK (229.405 of this chapter) is 2 not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting shares held by non-affiliates of the Registrant on June 12, 1998 (based on the average over-the-counter bid and asked prices of such stock on such date) was $60,072,000. Indicate the number of shares outstanding of each of the registrant's classes of common stock as of June 12, 1998: Common Shares 10,012,000 Portions of the Registrant's definitive Proxy Statement for its September 15, 1998, Shareholders' meeting ("Proxy Statement") (which Proxy Statement has not been filed as of the date hereof) are incorporated into Part III as set forth herein. Portions of the Registrant's Annual Report to Shareholders for the year ended March 31, 1998 ("Annual Report") are incorporated into Part II as set forth herein and only such portions of the Annual Report as are specifically incorporated by reference are thereby made a part of this Annual Report on Form 10-K. 2 3 PART I Item 1. Business Chad Therapeutics, Inc. ("CHAD" or the "Company") was organized in August, 1982, to develop, produce and market respiratory care devices designed to improve the efficiency of oxygen delivery systems for both home and hospital treatment of patients who require supplemental oxygen. The Company introduced its first respiratory care device in the market in June, 1983, and has introduced additional respiratory care devices in subsequent years. Pulmonary Disease and Oxygen Therapy The Company was organized to pursue the development and marketing of devices which improve the efficiency of systems used to administer oxygen to patients requiring supplemental oxygen. These are primarily patients suffering from chronic obstructive pulmonary diseases. Chronic obstructive pulmonary diseases (COPD) are progressive, debilitating conditions that affect millions of Americans, severely limiting their activities and shortening their lives. Such conditions, which include chronic bronchitis, emphysema and severe asthma, decrease the capacity of the lungs to oxygenate the blood. To make up for this deficiency, it is common medical practice to administer supplemental oxygen, usually on a 24 hours per day basis in an amount sufficient to increase blood oxygenation to near normal levels. A report issued in September, 1981, by the National Heart, Lung and Blood Institute of the National Institutes of Health (NIH) stated that chronic obstructive pulmonary diseases were the fastest rising cause of death in the United States, accounting for approximately 2.5% of all deaths and costing more than $15 billion a year in health care and lost time and wages. The NIH Report estimated that in 1981 there were approximately 9 million people in the United States suffering from chronic bronchitis and emphysema. More recently, the Epidemiology and Statistics Unit of the American Lung Association reported that in 1989 there were 14.6 million Americans suffering from COPD. This report also notes that the death rate from COPD has increased by 28.5 percent in the decade from 1979 to 1989. Some authorities estimate that as many as 20 million Americans who are now affected by COPD will eventually require supplemental oxygen. 3 4 Although precise data are not available, various individual and institutional sources and reports estimate that there are more than 1 million home care patients receiving supplementary administration of oxygen. Total dealer revenues for home oxygen therapy were estimated at over $2 billion for 1996. Medicare, which accounts for about 60% of home oxygen dealers' revenues, expected to spend almost $1.5 billion in 1996 for home oxygen as compared to $1.4 billion in 1995 according to officials of the Congressional Budget Office. Market revenues for home oxygen have grown consistently at 8-10% per year for the past five years. This is due to the increasing number of COPD patients as well as the move to home care and out of hospitals. Growth in the utilization rate for home oxygen is projected by the Congressional Budget Office to continue at a rate averaging approximately 8% per year through 2002. Chronic obstructive pulmonary diseases are also prevalent in other countries, particularly in some European nations where the incidence is higher than in the United States. The potential international market for home oxygen is expected to grow to 150% of the U.S. market before the end of the decade. The primary oxygen supply for home patients is provided from cylinders containing compressed gaseous oxygen (5-10% of users), reservoirs containing liquid oxygen (20-25%) or by means of concentrators which concentrate oxygen from the ambient air (65-75%). Standard oxygen delivery systems are characteristically inefficient, permitting over 67% of the oxygen supply delivered to the patient to be wasted, primarily because the oxygen is administered steadily to the patient, even while he is exhaling. Since the normal breathing cycle consists of an exhalation period which is approximately twice as long as the inhalation period, at least two-thirds of the oxygen from this continuous flow system is wasted. Furthermore, it is generally accepted that the oxygen breathed in during the first one-third of the inhalation period provides most of the oxygenation benefit to the patient. In June, 1989, the home oxygen market changed. A new procedure for payment by Medicare for home oxygen services became effective. This new procedure provides a prospective flat fee monthly payment based solely on the patient's prescribed oxygen requirement and disregards modality, the type of system in use. Prior to that time, dealers were reimbursed on the basis of total oxygen delivered by the dealer and reimbursement also varied based on the modality used and other variables. The prior procedure tended to encourage waste and inefficiency. Consequently, with the incentive 4 5 to operate efficiently, inexpensive concentrators have grown in popularity because of low cost and less frequent servicing requirements. At the same time interest heightened in oxygen conserving devices which can extend the life of oxygen supplies and reduce service calls by dealers. There is also a separate fixed allowance from Medicare for patients who need to be mobile and therefore require portable oxygen systems. In January, 1998, the monthly amount that Medicare now reimburses for home oxygen was reduced by 25% and an additional 5% reduction is scheduled for January, 1999. While the long term impact of this reduction may be to cause home care dealers to seek products that provide even greater cost saving efficiencies, the concerns over the size of these cuts over the past year has, in many cases, resulted in the provision of systems to patients that do not provide truly ambulatory oxygen. While these cost pressures have intensified, mobility has increased in importance as the treatment of pulmonary patients has moved away from hospitals and into home care. Also, leading authorities now state that maintenance and improvement of the patient's quality of life should be the major objective in the treatment of COPD. Maintaining quality of life and compliance with prescribed exercise programs require that the patient be as mobile as possible and thus increase the demand for portable oxygen equipment. CHAD's Products Recognizing the need for more efficient oxygen delivery systems, the Company has pursued, since its inception, the development and marketing of devices which are designed to conserve oxygen. The benefits of such improvements include substantial cost savings and increased mobility for ambulatory patients who require portable oxygen supplies. These devices extend the life of oxygen supplies, make possible more compact and longer lasting portable systems and thereby improve the quality of life for home oxygen patients. OXYMIZER and OXYMIZER Pendant Oxygen-Conserving Devices. In June, 1983, the Company began marketing its first product, the OXYMIZER disposable oxygen-conserving device, a unique, patented, disposable device developed to provide up to 4 to 1 savings of oxygen when used with any oxygen supply source. 5 6 The OXYMIZER device contains a collapsible reservoir which captures incoming oxygen delivered during expiration and prevents its waste. The oxygen captured in this reservoir is then inhaled by the patient during the first instant of his next inspiration. The OXYMIZER device thus both conserves oxygen and provides the patient with an extra rich supply of oxygen at the beginning of the inhalation period when it can be most effectively utilized. Extensive clinical testing and trials over the past fourteen years have repeatedly demonstrated that patients using the OXYMIZER device are able to achieve equivalent blood oxygenation levels while using significantly less oxygen. There have been more than 32 clinical evaluations from institutions worldwide, that have confirmed the efficacy and oxygen savings realized by patients who use the OXYMIZER devices. The greater efficiency provided by the OXYMIZER devices over standard oxygen delivery systems also permits home health care patients to achieve greater mobility by enabling them to use smaller portable cylinders or by obtaining two to four times the life from standard sized portable cylinders. For home oxygen dealers the disposable OXYMIZER devices afford the cost advantages of oxygen conservation without capital investment in expensive equipment. In hospitals the OXYMIZER devices are reported to be frequently used for maintenance of certain patients requiring higher flow levels of oxygen without having to resort to uncomfortable oxygen masks. The Company is pursuing a marketing strategy which emphasizes the cost savings, efficiencies and level of patient comfort associated with the use of the OXYMIZER devices. See "Marketing" and "Competition". The OXYMIZER Pendant device is similar to the OXYMIZER device, except that its reservoir is located in a "pendant" which hangs over the patient's chest rather than under the nose. The OXYMIZER Pendant has a more traditional appearance than the OXYMIZER. The Company began marketing the OXYMIZER Pendant in August, 1984, and to date sales have approximated those achieved by the OXYMIZER device. Total sales of these two devices accounted for approximately 5% of the Company's sales in 1998. OXYMATIC Electronic Oxygen Conservers. The Company began marketing the OXYMATIC conserver in March, 1986. This product is a small electronic device, designed for use with portable oxygen 6 7 systems. The OXYMATIC conserver electronically senses the optimal moment in the breathing cycle for delivery of oxygen and at that moment, releases a very brief pulse of oxygen to the patient. The OXYMATIC conserver concentrates the administration of oxygen during the first one-third of the inhalation phase, when oxygen is most efficiently utilized. Through its optimal efficiency the OXYMATIC electronic conserver makes possible oxygen savings ratios of from 4 to 1 up to 12 to 1 depending on the user's breathing rate. In clinical experience the average saving has been shown to be 7 to 1 - about twice the efficiency of most competitive products. There have been at least twelve controlled clinical trials and studies of patient groups using the OXYMATIC conserver, all of which have confirmed its efficacy and efficiency. In May, 1995, the Company introduced the new OXYMATIC Model 301 which replaced the previous model. This new model incorporates improved electronics, providing a longer battery life and other improvements which make it more user friendly. In June, 1993, the Company introduced a different version of the OXYMATIC conserver, the OXYMATIC - 2400. This model incorporates substantial improvements and additional features, such as an alarm system, which are designed to allow it to be used 24 hours a day with both primary and portable oxygen sources. The OXYMATIC - 2400 conserver affords the same oxygen savings ratios as the original OXYMATIC conserver. The OXYMATIC conservers accounted for approximately 38% of the Company's sales in 1998. These amounts do not include OXYMATIC devices sold as part of OXYLITE systems. OXYLITE Complete Portable Oxygen System. The Company also markets eight OXYLITE complete portable oxygen systems, each of which is available with either the OXYMATIC Model 301 conserver or the OXYMATIC - 2400 conserver. These systems combine the OXYMATIC conserver with small, lightweight oxygen cylinders and lightweight pressure regulators in an attractive carrying pouch. The OXYMATIC conserver extends the time the contents of the cylinders will last by an average of seven times. They provide ambulatory patients with greater mobility and less weight. These systems offer a superior alternative to commonly used liquid oxygen systems for mobile patients and are more cost effective for homecare dealers to supply. OXYLITE system and cylinder sales in 1998 accounted for approximately 44% of the Company's total sales, of which 52% represents the sales value of OXYMATIC conservers. 7 8 OXYCOIL Coiled Oxygen Tubing. In January, 1986, the Company began marketing the OXYCOIL coiled oxygen tubing, a device which replaces the standard supply tubing for the OXYMIZER devices, the OXYMATIC conserver or conventional nasal cannulas. The OXYCOIL tubing is a convenience and safety device which can be used with any oxygen system to help keep the supply tubing out of the patients' way, thus minimizing the tripping and tangling problems associated with standard supply tubing. OXYCOIL tubing sales in 1998 accounted for approximately 3% of the Company's total sales. TOTAL 0[subscript]2 Delivery System. In January, 1998, the Company began marketing the TOTAL 0[subscript]2TM Delivery System. This system provides stationary oxygen for patients at home, portable oxygen including an oxygen conserving device for ambulation and a safe and efficient mechanism for filling portable oxygen cylinders. This should provide home care dealers with a means to deal with the 25% cut in home oxygen reimbursement that went into effect on January 1, 1998, by reducing the monthly cost of servicing patients while at the same time providing them with a higher quality of service. This can be accomplished as the home care dealer will no longer be required to make regular monthly service calls to deliver full portable cylinders and the patient will no longer be dependent on the dealer for those deliveries to obtain full cylinders. While sales of the TOTAL 0[subscript]2 system have just begun, amounting to 3% of total sales for 1998, the potential for this product is significant as the average selling price is approximately four times that of the OXYMATIC and OXYLITE systems. No assurances can currently be given regarding the level of success the Company may achieve with the TOTAL 0[subscript]2 system. The technology for each of the devices described above belongs to the inventors thereof. The Company has acquired exclusive licenses to manufacture and market the OXYMIZER devices, the OXYMATIC conservers, the OXYCOIL tubing and the TOTAL 0[subscript]2 system. See "Licensing and Related Agreements". Other Products. The Company also offers a variety of ancillary products which support the principal oxygen conserving products. These include oxygen cylinders of various sizes and compositions, regulators, cannulas and connecting tubing and assorted carrying pouches, which account for less than 7% of total sales in 1998. Products Under Development It is the Company's objective to continuously improve and add to its oxygen conserving and related products. In April, 1996, the Company entered into an exclusive development contract with an 8 9 outside vendor to develop unique oxygen therapy products. The first product developed from the project was the TOTAL 0[subscript]2 system. No assurance can be given that any products developed pursuant to this contract will be successfully marketed or that the Company will ever derive significant revenues or earnings from the sale of such products. Research and Development For the year ended March 31, 1998, the Company expended approximately $713,000 on research and development and has expended approximately $2,676,000 since its inception in August, 1982. The Company operates in an industry which is subject to rapid technological change, and its ability to compete successfully depends upon, among other things, its ability to stay abreast or ahead of new technological developments. Accordingly, the Company expects to expend increasing amounts for the development or acquisition of new products or the improvement of existing products. In the next fiscal year the Company expects to spend approximately $800,000 on several projects. The Company conducts research and development in the electronics area internally and also utilizes the services of outside firms and consultants for its research and development activities. Licensing and Related Agreements The Company has entered into license agreements (the "Inventors License Agreements") with Brian L. Tiep, M.D., Robert E. Phillips and Ben A. Otsap, the inventors of the OXYMIZER device (the "Inventors"), with respect to that device and each of the additional oxygen conserving devices developed by them. At the present time, the Company has licensed the OXYMIZER device, the OXYMIZER Pendant device and the OXYMATIC conserver, thereby acquiring exclusive rights to manufacture and market such products. Pursuant to the Inventors License Agreements, the Inventors grant to the Company an exclusive license (with the right to grant sublicenses) to manufacture, use and sell such device. The Inventors License Agreements provide that the Company pay royalties to the Inventors on the net proceeds of sales of the device covered by the agreement at the rate of 6% on amounts up to $10 million and 3% on amounts of $10 million or more. The Inventors License Agreements also provide that the Company pay minimum advance royalties for each license year in the amount of $10,000 for each year. The advance payments are to be applied toward royalties payable for the corresponding license year, and any amounts paid by the Company under one agreement (except those on the OXYMIZER device), in excess of the minimum, may be applied by the Company 9 10 against the minimum payable under any other such agreement. The Company is obligated to prosecute and defend, at its own expense, any infringement suits related to manufacture or sale of each device covered by any such agreement. Each Inventors License Agreement continues until the expiration of the last to expire of any patent covering the related device or, if no patent issues, for 17 years. The Inventors may terminate the Inventors License Agreements at an earlier date if the Company is in arrears for 60 days on any royalty payment or if the Company defaults in performing any other term of the agreement and fails to cure such default within 60 days. The Company has also entered into a license agreement (the "Litton License Agreement") with the Life Support Division of Litton Systems, Inc. for the TOTAL O(2) Delivery System. Pursuant to the Litton License Agreement, the Licensor grants to the Company an exclusive license (with the right to grant sublicenses) to manufacture, use and sell such device in the health care market. The Litton License Agreement provides that the Company pay royalties to the Licensor on the net proceeds of sales of the device covered by the agreement at the rate of 4%. The Litton License Agreement continues until the expiration of the last to expire of any patent covering the related device or until the Company ceases uses of the licensed technology. The Licensors may terminate the Litton License Agreement at an earlier date if the Company is in arrears for 30 days on any royalty payment or if the Company defaults in performing any other material obligation of the agreement and fails to cure such default within 30 days. Manufacturing and Sources of Supply The Company tests and packages its products in its own facility. Some other manufacturing processes are conducted by other firms and the Company expects to continue using outside firms for certain manufacturing processes for the foreseeable future. All outside manufacturing is conducted under the supervision and control of the Company and with tooling provided by the Company. Pursuant to an oral agreement, the Company purchases semi-finished units of the OXYMIZER and OXYMIZER Pendant devices from a supplier in Southern California. Final assembly and packaging are completed at the Company's facilities. The Company does not contemplate entering into a formal written agreement for these units. This arrangement is terminable at will by either party. The Company believes that other injection molding facilities would be available in the event of a termination of this arrangement. 10 11 Production of the OXYMATIC Model 301 and 2400 is being handled internally with only a portion of electronic assembly being subcontracted outside the Company. The Company is currently subcontracting with two electronic assembly facilities and believes that other facilities would be available in the event of an interruption of supply from the existing facilities. Pursuant to oral agreements, the Company purchases components for its OXYLITE systems (other than the OXYMATIC conserver) from several suppliers. These arrangements are terminable at will and the Company believes other suppliers would be available in the event of termination of these arrangements. Production of the TOTAL 0[subscript]2 system is being handled internally with a number of subassemblies being subcontracted outside the Company. The Company believes that there are alternate sources of supply for these subassemblies, including internal manufacturing as production quantities increase. The Company is not aware of any shortages of materials necessary for the manufacture of its products. The Company provides customers the right to return merchandise for credit but does not provide extended payment terms. Marketing The Company's products are designed to reduce the cost of health care while maintaining or enhancing the therapeutic benefits to the patient, and improving the user's quality of life. The Company's marketing efforts have focused primarily on providing home oxygen suppliers with products that they can utilize to increase their revenues, while reducing their costs. Homecare dealers have reportedly increased their revenues by using the Company's OXYLITE complete portable oxygen systems or by locally assembling small portable systems incorporating the Company's OXYMATIC conserver as a vehicle to attract new and additional patients to their business. The Company believes these lightweight, long-lasting portable systems have both high professional and patient acceptance which allows the supplier promoting these products to attract new and additional customers. The Company has been advised that medical professionals, who frequently refer patients to specific home oxygen suppliers, find that these systems assist patients in more easily complying with prescribed exercise programs and help them to achieve the therapeutic benefits of maintaining a lifestyle as normal as possible. Patients, most of whom are free to select their oxygen supplier, are reportedly receptive to changing suppliers in order 11 12 to obtain equipment that will allow them to travel and maintain their quality of life. Approximately 80% of all home oxygen patients are covered by Medicare and other government programs. Since June 1989, home oxygen suppliers have been reimbursed by Medicare on a fixed monthly fee basis. The monthly reimbursement amount does not vary, as in the past, with either the type of oxygen delivery equipment provided or the amount of oxygen supplied. Since monthly per patient revenues are fixed, home oxygen suppliers can only increase their per patient profitability by reducing costs. The Company's oxygen conserving products and TOTAL O(2) Delivery System allow these suppliers to decrease their costs while providing their patients with improved therapeutic benefits and quality of life. While the home respiratory care dealer remains the primary focus of the Company's marketing efforts, this focus has been augmented by a major effort to increase professional awareness. Promotional programs were initiated which targeted respiratory care physicians, nurses and therapists. A Medical Advisory Committee was formed composed of nine physicians who are among the world's leading respiratory authorities. The Company markets its products directly to home oxygen suppliers throughout the U.S. The Company currently has a Marketing Director, a Marketing Manager, a marketing assistant, a National Sales Manager and seven in-house sales and customer service representatives who are in regular and frequent proactive telephone sales contact with customers and potential customers. The Company also utilizes extensive direct mail, trade show attendance, and trade advertising to promote the benefits of its products to home care dealers. Additionally, the Company actively seeks to increase professional awareness of its products through professional advertising and participation in professional meetings. Home oxygen therapy markets outside the United States are, in most cases, at a much earlier stage of development. In many countries, these patients are cared for in domiciliary settings. As the trend develops to move patients into home care, opportunities for the Company's products should increase. Sales of the OXYMATIC conserver in Europe, Canada and Japan have become an important part of the Company's business. Based on industry market research projections, the Company expects the market potential to increase to 150% of the U.S. potential within the current decade. The Company has entered into exclusive distributorship agreements in Germany, Canada, Japan, and Australia. The Company's 12 13 largest distributor in Germany covers portions of the European Community, however, reimbursement pressures in Germany may limit growth during the upcoming year. The Company also has non-exclusive distributors in many other countries. Sales outside of the United States will subject the Company to certain risks, including those involving political and economic factors, interruption of shipments of products, currency fluctuations and devaluations and governmental restrictions and regulations. Customers, Backlog and Orders The Company presently has an active list of approximately 4,400 dealer and hospital customers. Based upon information developed from various lists the Company believes that there are approximately 7,000 to 8,000 oxygen dealers and 3,000 general hospitals in the United States which are potential customers or customer sources for the Company. Of these 7,000 to 8,000 home oxygen dealers, approximately 30% are represented by three major national chain accounts. One such national account, Apria Home Healthcare, accounted for 11% of the Company's revenues in 1998. Financial Information Relating to Foreign and Domestic Operations and Export Sales
1998 1997 1996 ------- ------- ------- Sales (thousands): United States $14,866 23,567 17,832 Europe 632 1,146 961 Other 1,095 1,448 1,566 ------- ------- ------- Total $16,593 26,161 20,359 ======= ======= ======= Gross profit(thousands): United States $ 7,197 13,509 10,630 Europe 267 572 476 Other 459 724 773 ------- ------- ------- Total $ 7,923 14,805 11,879 ======= ======= =======
All identifiable assets are located in the United States. At March 31, 1998, the Company had a backlog of $510,000 for TOTAL O(2) systems, including $149,000 related to systems for beta testing. In prior years the Company has not had any backlog of orders for any of its products. As production levels for the TOTAL 0[subscript]2 system increase, the Company presently intends to maintain a 13 14 large enough inventory to ship all of its products immediately upon receipt of orders. The Company believes that such an inventory is necessary to meet the requirements of its customers. Competition The Company is aware of several demand valve, electronically controlled devices currently being marketed. Of these devices, those that have been the principal competitors of the OXYMATIC conserver in the past were targeted primarily to a specific segment of the market - liquid oxygen usage. Several companies, including Invacare, Nellcor/Puritan Bennett and Sunrise/De Vilbiss, market small (5.5 lbs.) portable liquid oxygen systems incorporating simple oxygen conserving devices which double the useful life of these systems. Although these units allow longer ambulation and/or reduce the weight of portable liquid oxygen, they are heavier than the smallest OXYLITE system and provide less ambulatory time due to the greater efficiency of the OXYMATIC conserver, which provides at least double the oxygen savings of these conservers. Also these units are more expensive than OXYLITE systems and still require the supplier to make frequent and costly oxygen deliveries. The Company does not know the levels of sales achieved by the companies marketing these systems. Several of these competitors are now marketing combinations of conservers, regulators and small cylinders in direct competition with the Company's OXYLITE systems. Many of these products utilize conservers that provide 2:1 to 3:1 savings ratios. As a result, these units while weighing about the same as similar OXYLITE systems provide only 1/3 or 1/2 of the ambulation time provided by OXYLITE systems. In addition, the Company is aware of two companies marketing oxygen conserving devices which claim similar oxygen savings ratios as the OXYMATIC conserver. The Company believes that some of these competitors have been able to offer their oxygen conservers as part of a bundle of products with perceived pricing advantages over the Company's products; however, the Company believes the established reputation of its products for efficiency and reliability help offset these advantages. The Company does not know the level of sales achieved by these companies. There are several other types of portable oxygen systems which compete with the Company's OXYLITE systems but do not utilize oxygen conserving devices. Aluminum and steel oxygen cylinders with continuous flow are utilized by some oxygen suppliers as portable systems. Although they do provide users with some portability, their size and bulk limits their use by patients who need or want to be truly ambulatory. The most commonly used of 14 15 these cylinders is approximately three feet high, weighs over 20 lbs., and provides an average patient with less than 5 hours of oxygen. These systems are enjoying some level of success due to their lower unit price advantage. The OXYMATIC conserver, which provides an average oxygen savings of 7 to 1, allows the use of smaller, lighter cylinders and thus provides greater mobility. Until the availability of OXYLITE systems and the previously cited changes in Medicare oxygen reimbursement, liquid oxygen was the modality of choice for truly mobile users. Portable liquid oxygen systems which weigh 8 to 10 lbs., provide an average patient with 6 to 8 hours of oxygen, compared to the smallest OXYLITE system which weighs 4.5 lbs. and provides an average patient with 10.5 hours of oxygen. These systems are more costly than OXYLITE systems and require frequent and expensive (usually weekly) deliveries of bulk liquid oxygen to the patient's home. Although many oxygen suppliers continue to use and re-use existing inventories of liquid oxygen equipment to service ambulatory patients, purchases of new liquid oxygen equipment by home care dealers is decreasing. Patents and Trademarks The Company regards the products that it develops or licenses and its manufacturing processes as proprietary and relies on a combination of patents, trademarks, trade secret laws and confidentiality agreements to protect its rights in its products. U.S. patents have been issued covering the original OXYMIZER device, the OXYMIZER Pendant device, the OXYMATIC conserver and the TOTAL O2 Delivery System. A number of foreign patent applications pertaining to the Company's activities have also been issued. The Company pursues a policy of obtaining patents for appropriate inventions related to products marketed or manufactured by the Company. The Company considers the patentability of products developed for it to be significant to the success of the Company. To the extent that the products to be marketed by the Company do not receive patent protection, competitors may be able to manufacture and market substantially similar products. Such competition could have an adverse impact upon the Company's business. There can be no assurance that patents, domestic or foreign, will be obtained with respect to the Company's products, or that, if issued, they will provide substantial protection or be of commercial benefit to the Company. In addition, the patent laws of foreign countries may differ from those of the United States as to the patentability of the Company's products and processes and, 15 16 accordingly, the degree of protection afforded by foreign patents may be more or less than in the United States. In the United States, although a patent has a statutory presumption of validity, the issuance of a patent is not conclusive as to such validity or as to the enforceable scope of its claims therein. The validity and enforceability of a patent can be attacked by litigation after its issuance by the U.S. Patent and Trademark Office. If the outcome of such litigation is adverse to the owner of the patent in that the patent is held to be invalid, other parties may then use the invention covered by the patent. Accordingly, there can be no assurance that patents with respect to the Company's products, if issued, will afford protection against competitors with similar products, nor can there be any assurance that the patents will not be infringed upon or designed around by others. The Company has obtained U.S. registration for the trademarks "OXYMIZER", "OXYMATIC", "CHAD" and "OXYCOIL" and has filed an application for the trademark "TOTAL 0[subscript]2". A series of foreign applications to register the trademark "OXYMIZER" in a number of countries of commercial interest to the Company have been filed. Governmental Regulation The commercialization of the OXYMIZER, OXYMATIC and TOTAL 0[subscript]2 devices is subject to the Federal Food, Drug and Cosmetic Act (the "Food and Drug Act") and to regulations issued thereunder. The Company anticipates that commercialization of other devices which it intends to market will also be subject to the Food and Drug Act. The Food and Drug Act is administered by the FDA, which has authority to regulate the marketing, manufacturing, labeling, packaging and distribution of products subject to the Food and Drug Act. In addition, there are requirements under other federal laws and under state, local and foreign statutes which may apply to the manufacture and marketing of the Company's products. The Medical Device Amendments of 1976 to the Food and Drug Act (the "Amendments") and the Safe Medical Device Act of 1990 significantly extended the authority of the FDA to regulate the commercialization of medical devices. The Amendments established three classifications of medical devices: Class I, Class II and Class III. With respect to all three classes, the general provisions of the Food and Drug Act prohibit adulteration and misbranding. A medical device may be adulterated if the device is or could be adversely affected by its methods of manufacture, storage or packaging. A medical device may be misbranded if its labeling is false or misleading or if its labeling does not contain specific 16 17 information required by law applicable to such type of device. In addition, failure to register a medical device covered under the Food and Drug Act with the FDA will render it misbranded under the Food and Drug Act. All manufacturers of medical devices must register with the FDA and, with their initial registration, list all medical devices produced by them. This listing must be updated annually. In addition, prior to commercial distribution of additional devices, the manufacturer must file with the FDA and receive approval prior to the commencement of such commercial distribution, a notice setting forth certain information about the device, including the classification into which the manufacturer believes it falls. Class I devices are subject only to the general controls concerning adulteration, misbranding, good manufacturing practices, record keeping and reporting requirements. Class II devices must, in addition, comply with performance standards as promulgated by the FDA. The Company has registered with the Bureau of Medical Devices of the FDA as a Medical Device Establishment and with the Department of Health Services of the State of California as a Medical Device Manufacturer. In addition, the Company has developed procedures to comply with FDA standards concerning good manufacturing practices, record keeping and reporting. The Company has filed notification submissions pursuant to Section 510(k) of the Food and Drug Act of its intent to market the OXYMIZER, the OXYMIZER Pendant, the OXYMATIC conserver, the OXYCOIL and the TOTAL 0[subscript]2 Delivery System; it has been granted permission by the FDA to market the OXYMIZER and the OXYMIZER Pendant as Class I devices. Permission has been granted to market the OXYMATIC, the OXYCOIL and TOTAL 0[subscript]2 Delivery System as Class II devices. Employees As of June 12, 1998, CHAD had 87 full-time and no part-time employees. Fifty-three of the Company's employees are engaged in manufacturing and the remainder are engaged in marketing, sales, administration and management. None of the Company's employees are represented by unions; the Company believes its employee relations are satisfactory. The Company will employ additional personnel in all phases of its activities as required by the growth in its activities. The number of additional personnel will be dependent on sales levels of individual products. 17 18 Item 2. Properties. The Company's principal offices and manufacturing facilities are situated in premises located in Chatsworth, California and consist of approximately 55,500 square feet, at a monthly rental fee of $24,500 pursuant to a lease expiring in June, 2003. Management believes this facility should adequately handle the Company's needs for the foreseeable future. The Company does not own any real property and does not anticipate acquiring any in the foreseeable future. Item 3. Legal Proceedings. The Company becomes involved in legal proceedings in the ordinary course of business. The Company maintains product liability insurance in an amount deemed customary in the industry for protection of the Company against potential product liability claims. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. PART II Item 5. Market for Registrant's Common Equity and Stockholder Matters. The information required herein is hereby incorporated by reference to the information contained under the caption "Corporate Data" in the Company's Annual Report. Item 6. Selected Financial Data. The information required herein is hereby incorporated by reference to the information contained under the caption "Selected Financial Data" in the Company's Annual Report. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information required herein is hereby incorporated by reference to the information contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report. 18 19 Item 8. Financial Statements and Supplementary Data. The information required herein is hereby incorporated by reference to the Financial Statements and the Notes thereto contained in the Company's Annual Report. Item 9. Disagreements on Accounting and Financial Disclosure. None. PART III Item 10. Directors and Executive Officers of the Registrant. The information required herein is hereby incorporated by reference to the information appearing under the captions "Election of Directors" and "Executive Officers" in the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission. Item 11. Executive Compensation. The information required herein is hereby incorporated by reference to the information appearing under the caption "Compensation of Directors and Executive Officers" in the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required herein is hereby incorporated by reference to the information appearing under the caption "Voting Securities and Principal Holders Thereof" in the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission. Item 13. Certain Relationships and Related Transactions. None. 19 20 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) (1) Financial Statements. Included in Part II of this Report: Independent Auditors' Report Balance Sheets -- March 31, 1998 and 1997 Statements of Operations -- Years ended March 31, 1998, 1997 and 1996. Statements of Shareholders' Equity -- Years ended March 31, 1998, 1997 and 1996. Statements of Cash Flows -- Years ended March 31, 1998, 1997 and 1996. Notes to Financial Statements. (a) (2) Financial Statement Schedules. None. (3) Exhibits. 3.1 Articles of Incorporation of the Registrant, as amended***** 3.2 Bylaws of the Registrant, as amended* 10.3 OXYMIZER License Agreement, as amended, with Robert E. Phillips, Brian L. Tiep, M.D. and Ben A. Otsap* 10.5 Pulser System License Agreement, as amended, with Robert E. Phillips, Brian L. Tiep, M.D. and Ben A. Otsap. (The Pulser System is now called the OXYMATIC.)* 10.7 OXYMIZER Pendant License Agreement, as amended, with Robert E. Phillips, Brian L. Tiep, M.D. and Ben A. Otsap* 20 21 10.20 OXYCOIL tubing License Agreement with Mary Smart (licensed under the name Respi-Coil).*** 10.23 Summary plan description for Chad Therapeutics, Inc. Employee Savings and Retirement Plan**** 10.24 1994 Stock Option Plan****** 10.25 Lease on real property at 21622 Plummer Street, Chatsworth, California****** 10.26 TOTAL O2 Delivery System License Agreement, as amended, with the Life Support Division of Litton Industries, Inc. 13.1 Annual Report to Shareholders for the year ended March 31, 1998. 23.1 Consent of Independent Accountant 28.1 Letter from the FDA authorizing the Company to market the OXYMIZER oxygen conserving device as a Class 1 device.* 28.2 Letter from the FDA authorizing the Company to market the OXYMIZER Pendant oxygen conserving device as a Class 1 device.** 28.5 Letter from the FDA authorizing the Company to market the OXYMATIC electronic oxygen conserver as a Class 2 device.*** 28.6 Letter from the FDA authorizing the Company to market the OXYCOIL coiled oxygen tubing as a Class 2 device.*** 28.7 Letter from the FDA authorizing the Company to market the TOTAL O2 Delivery System as a Class 2 device (b) Reports on Form 8-K - None filed. (c) Index to Exhibits. (d) Financial Statement Schedules - None 21 22 - -------------- * Previously filed as an Exhibit to the Registrants' Registration Statement on Form S-18, File No. 2-83926. ** Previously filed as an Exhibit to the Registrants' Annual Report on Form 10-K for the year ended March 31, 1984. *** Previously filed as an Exhibit to the Registrants' Annual Report on Form 10-K for the year ended March 31, 1986. **** Previously filed as an Exhibit to the Registrants' Annual Report on Form 10-K for the year ended March 31, 1993. ***** Previously filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended March 31, 1994. ****** Previously filed as an exhibit to the Registrant's Annual Report on Form 10-K for the year ended March 31, 1996. 22 23 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on the 19th day of June, 1998. CHAD THERAPEUTICS, INC. By /s/ Thomas E. Jones ----------------------------------------- Thomas E. Jones, Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Thomas E. Jones Chief Executive Officer June 19, 1998 - ----------------------- and Director (Principal Thomas E. Jones Executive Officer) /s/ Francis R. Fleming President, Chief June 19, 1998 - ----------------------- Operating Officer and Francis R. Fleming Director /s/ Earl L. Yager Senior Vice President, June 19, 1998 - ----------------------- Chief Financial Officer Earl L. Yager and Secretary and Director (Principal Financial and Accounting Officer) /s/ Charles R. Adams Chairman of the Board June 19, 1998 - ----------------------- Charles R. Adams /s/ David L. Cutter Director June 19, 1998 - ----------------------- David L. Cutter /s/ John C. Boyd Director June 19, 1998 - ----------------------- John C. Boyd /s/ Norman Cooper Director June 19, 1998 - ----------------------- Norman Cooper /s/ Philip Wolfstein Director June 19, 1998 - ----------------------- Philip Wolfstein
23 24 EXHIBIT INDEX
Exhibit Index Sequentially Exhibit No. Document Numbered Page - ----------- ------------- ------------- 13.1 Annual Report to Shareholders for the year ended March 31, 1998 23.1 Consent of Independent Accountant 10.26 TOTAL O2 Delivery System License Agreement, as amended, with the Litton Life Support division of Litton Industries, Inc. 28.7 Letter from the FDA authorizing the Company to market the TOTAL O(2) Delivery System as a Class 2 device
24 EX-10.26 2 EXHIBIT 10.26 1 EXHIBIT 10.26 LICENSE AGREEMENT This agreement, effective as of the 23rd day of May, 1996 is entered into by and between the Life Support Division of Litton Systems, Inc., a Delaware Corporation, having an address at 2734 Hickory Grove Road, Post Office Box 4508, Davenport, Iowa, 52808-4508 (hereinafter "Licensor") and Chad Therapeutics, Inc., a California Corporation, having an address at 9445 DeSoto Avenue, Chatsworth, California 91311 (hereinafter "Licensee"). WHEREAS Licensor has developed oxygen gas concentrator and pressure intensifier technologies and related products for applications in the military, industrial and recreational markets and is of the belief that such technologies have application in the health care market. WHEREAS Licensee has demonstrated capabilities for manufacturing and marketing oxygen delivery systems in the health care market. WHEREAS the parties desire to undertake a program to redesign and repackage Licensor's technologies referenced hereinabove into a combined oxygen concentrator and oxygen cylinder charging system which will utilize Licensor's technologies to provide a product suitable for application in the health care market. WHEREAS the parties have entered into a Product Design Agreement dated April 16, 1996 which, as one of its terms and conditions, requires that there will be a license agreement permitting Licensee to utilize the Licensor's technologies for the manufacture and sale of the aforementioned product in the health care market. NOW THEREFORE, in consideration of the foregoing premises, the mutual promises contained herein and other good and valuable consideration, the receipt of which is hereby acknowledged, and intending to be legally bound hereby Licensor and Licensee hereby agree as follows: 1 2 ARTICLE I Definitions: As used herein: A. Territory shall mean the world with the exception of Japan, China, Taiwan, Korea, Hong Kong, Singapore and Malaysia. One year after the effective date of this agreement and if the aforementioned expected countries are available for exclusive licensing of the product, Licensor shall negotiate in good faith with Licensee for the extension of this license agreement to include the excepted territories. B. "Product" shall mean the combination of an oxygen concentrator and pressure intensifier and cylinder charging system with appropriate valves, controls and the like and suitable packaging made according to the specification in paragraph 1 B of the above referenced Product Design Agreement, which product shall be marketed and sold as a health care product. C. "Field of Use" shall mean the health care market excluding the military, industrial and recreational markets for gas generation delivery or supply systems. D. "Licensed Technology" shall mean Licensor's oxygen concentrator and pressure intensifier technology as embodied in Licensor's proprietary information, U.S. patent numbers 5,071,543, expiring on December 10, 2008 and 5,354,361, expiring on October 11, 2011 and related foreign patents, and Licensor's invention disclosure docket number LILS-149 for which a patent application shall be pending in the United States and selected foreign countries. E. "Net Selling Price" shall mean the gross sales or lease price by which Licensee transfers title or possession of a Product less only usual trade discounts, sales tax which the seller has to pay or absorb, custom duties and transportation and insurance charges, if not included in the gross price, and any and a federal, foreign, state or local taxes (except income tax) incurred by the seller on such sales or leases. 2 3 F. "Sales, Sell or Sold", shall mean any sale, transfer, lease, license, permission to use or other transfer of the right of possession or title or other conveyance by Licensee. G. "Proprietary Information" shall mean any scientific or technical information, design, process, procedure, formula or improvement that is competitively advantageous and secret and that is not generally known in the industry and any data or information having competitive advantages which may include, but not be limited to, data, data bases, software, product plans, strategies, materials, customer names and other information related to customers, price fists, pricing policies and financial information which the parties consider sensitive and which is not generally known to the public. The term Proprietary Information specifically includes those items which might otherwise be known as knowhow or trade secrets. It shall not include information which is not marked as "Proprietary Information" or an equivalent term. ARTICLE II License Grant: A. Licensor hereby grants to Licensee an exclusive, nontransferable, royalty bearing license with a right of sublicense to make, use and sell Products throughout the Territory in the Field of Use. B. Any provision of this agreement to the contrary notwithstanding, Licensor reserves the right to make, use and sell Products according to the Licensed Technology in others than the Field of Use anywhere and in the Field of Use outside the Territory and to use the Licensed Technology in the military, industrial and recreational markets for any purpose. ARTICLE III Consideration and Payments: 3 4 A. In consideration of the granting herein of the license as described in Article II, Licensee shall pay Licensor: 1. A nonrefundable licensing fee in the amount of $1,250,000.00 to be paid in the following installments: a. On the effective date of this agreement a payment of $150,000.00. b. On each of the dates July 15, 1996 and November 15, 1996 payments in the amount of $250,000.00, respectively. C. On each of the dates February 15, 1997 and April 15, 1997 payments of $300,000.00, respectively. 2. Royalties at the rate of 4% of the Net Selling Price of Products sold or leased by Licensee or any sublicensee under this agreement. In the event that by reason of the action of a court or tribunal of competent jurisdiction no valid claim of any existing U. S. patent or U.S. patent which matures from a patent application owned by Licensor covers the Product, Licensee or any sublicensee shall have the right to reduce the aforesaid royalty rate to 2% of the Net Selling Price. Additionally, Licensee or any sublicensee shall deposit the amount of the difference between 4% and 2% royalties into escrow until such time that the validity or enforceability of any such claim covering a Product is determined from which there can be no further appeal or review. If all claims covering a Product are determined invalid or unenforceable and there can be no further appeal or review of such decision, Licensee or a sublicensee shall have the right to dispose of the escrowed royalties in any manner they deem necessary and reasonable, otherwise the escrowed amounts shall be paid to Licensor. B. All payments to Licensor under this agreement shall be made in U.S. dollars at Licensor's address for notice. The payments listed in paragraph A1 shall be made on the stated dates. 4 5 The royalty payments shall be paid to Licensor quarterly on a calendar year basis. Payments for sales made during each quarter of each calendar year shall be made to Licensor within thirty (30) days after the last day of each calendar quarter. C. Licensee shall pay all royalties due hereunder to Licensor and Licensor shall not be required to look to any other entity for payment. ARTICLE IV Sublicenses: A. Subject to this paragraph, Licensee may grant sublicenses to persons or entities specifically approved in writing by Licensor, which approval shall not be unreasonably withheld, provided that each sublicense contains a provision that such sublicense and the rights thereby granted are personal to the sublicensee thereunder and such sublicense cannot be further assigned or sublicensed. B. Any sublicense granted pursuant to this Article shall be in accordance with the terms and conditions of this agreement. C. In respect of any sublicense granted by Licensee in accordance with this article, Licensee shall promptly pay to Licensor an amount equal to 25% of any lump sum or other payment, howsoever calculated, in addition to the royalties set forth in Article III above, made by the sublicensee thereunder in consideration for the grant of such sublicense to it by the Licensee. ARTICLE V Accounts: A. Not later than March 1 of each calendar year, Licensee shall furnish to Licensor a statement showing the total net sales of products made according to the Licensed Technology by 5 6 Licensee during the immediate preceding calendar year and the royalties payable thereon calculated in the manner required in Article III. B. Licensee shall keep at its usual place of business true and accurate accounts of all matters connected with the use of the Licensed Technology and the manufacture and sale of all Products and shall keep books of account relating to royalties payable hereunder containing true entries complete in every particular as may be necessary or proper for enabling the amount of such royalties to be conveniently ascertained. C. If requested in writing by Licensor, Licensee shall at all reasonable times produce evidence of the matters referred to in this Article V and shall permit such evidence to be verified by an independent accountant to be selected and paid for by Licensor. Licensee shall give such accountant all necessary facilities for verifying such evidence and shall give such information as may be necessary or proper to enable the amount of the royalties to be verified. ARTICLE VI Improvement: A. Should Licensee, or any consultant or employee of Licensee, during the term of this agreement make or discover any improvement in the Licensed Technology, whether patentable or not, Licensee shall forthwith disclose or cause the same to be disclosed to Licensor. Licensee shall own all right, title and interest in any such discovery or improvement. However, Licensee shall make available to Licensor any improvements or modifications it makes to the Licensed Technology and grant Licensor an irrevocable, nonexclusive, royalty free unrestricted license to use the improvements for the purposes stated in Article II, paragraph B. If so requested by Licensor, Licensee shall make available or supply to Licensor such information or data as is necessary or convenient for the proper understanding or use of such discovery or improvement. 6 7 B. If Licensor makes or discovers any improvement in the Licensed Technology, whether patentable or not, which if practiced would constitute an infringement of any patent included in the Licensed Technology or would be obvious to one skilled in the art in view of any description of the Licensed Technology, Licensor shall forthwith disclose or cause the same to be disclosed to Licensee and such improvement shall be deemed to be included in the term "Licensed Technology" and to be included in this agreement and be subject to the terms hereof ARTICLE VII Confidentiality: A. Licensee shall not disclose any Proprietary Information other than to Licensee employees who must have access to such information in order to carry out Licensee's obligations under this agreement, and to potential sublicensees of the Licensed Technology, providing such disclosure is in accordance with paragraph C of this Article. Prior to disclosure of Proprietary Information to Licensee employees, such employees shall be under a written obligation of confidentiality to Licensee consistent with this agreement. Trade secrets and knowhow shall be maintained in confidence by Licensee for so long as such information is maintained in confidence by Licensor. B. To protect Licensor's Proprietary Information, Licensee shall adopt security measures commonly observed in industries that rely on Proprietary Information. These measures shall include, but not be limited to, restricted access to such information, marking such information and the selective destruction of sensitive materials. Upon termination of this agreement, Licensee shall return or destroy all documents or materials embodying Licensor's proprietary information. C. Any disclosure of Proprietary Information by Licensee to potential vendors, subcontractors or sublicensees of the Licensed Technology shall be prohibited, unless such potential vendor 7 8 subcontractor or sublicensee has signed an agreement which imposes obligations of confidentiality and nonuse at least as restrictive as those imposed on Licensee hereunder. ARTICLE VII Initial Development and Full Use of Licensed Technology: Should Licensor not receive a minimum of $100,000.00 in royalties from Licensee during the third year of this agreement as measured from the effective date of hereof, $300,000.00 during the fourth year and $500,000.00 during the fifth year and each year thereafter, Licensor shall have the option to terminate the license granted hereunder, to allow this agreement to continue in full force and effect or to convert the exclusive license granted hereunder to a nonexclusive license. The exercise of this option shall be taken only on sixty (60) days written notice to Licensee. During the latter sixty (60) day period, Licensee may prevent such option from being exercised by paying Licensor an amount equal to the difference between the minimum royalty required for the year for which notice is given and the amount of royalty actually paid. ARTICLE IX Protection of Intellectual Property: A. The cost of preparing, prosecuting and maintaining the patent application included in the Licensed Technology and any other patent applications or copyright applications the Licensor determines to file on improvements as defined in Article VI shall be borne by Licensor. B. Licensee shall cooperate with Licensor in enforcing or policing intellectual property protection for the Licensed Technology and improvements as provided in Article X hereinbelow and by taking all appropriate measures including marking Proprietary Information as required. 8 9 ARTICLE X Notice of Infringement and Enforcement of Rights: A. Immediately upon Licensee's learning of any infringement, misappropriation or unauthorized use of Licensor's Proprietary Information, patents or other intellectual property rights pertaining to the Licensed Technology, Licensee shall promptly inform Licensor. B. If Licensee and Licensor agree to jointly pursue enforcement of Licensor's intellectual property rights, then the parties hereto shall share equally all costs, fees and/or expenses incurred in connection with enforcement of Licensor's intellectual property rights provided only that Licensor's maximum exposure for such costs, fees and expenses shall be the amounts of compensation paid and/or payable to Licensor by Licensee hereunder. Any payments accruing from such action to enforce Licensor's intellectual property rights shall be paid to Licensee and Licensor in proportion to the party's respective contributions to all costs, fees and/or expenses incurred in such action. C. In the event that either party shall determine for any reason that it does not choose to enforce Licensor's intellectual property rights then that party shall promptly notify the other party of such decision. The party choosing to enforce Licensor's intellectual property rights may then proceed with such enforcement action solely at its own expense and any and all recoveries shall be awarded solely and exclusively to that party. However, it is agreed that said other party shall cooperate in enforcement of the intellectual property rights, such as by providing witnesses and other evidence as needed by the enforcing party at the cost of the enforcing party. ARTICLE XI Indemnity: A. License hereby indemnifies holds harmless Licensor, its parent corporation, affiliates and 9 10 their employees, officers, board members and agents from and against all claims, suits, liabilities, damages, costs, fees, expenses or losses arising out of or resulting from Licensee's performance of this agreement, including any damages, losses or liabilities whatsoever with respect to death or injury to any person and damage to any property arising from the possession, use or operation of Products produced or sold by Licensee or its sublicensees or their customers in any manner whatsoever. This indemnity shall not apply to claims, suits, liabilities, damages, costs, fees, expenses or losses directly attributable to components or subassemblies supplied by Licensor, for use in Products of Licensee. B. Licensor hereby indemnifies and holds harmless Licensee and its employees, officers, board members and agents from and against all claims, suits, liabilities, damages, costs, fees, expenses or losses arising out of third party claims against Licensee (1) for patent, copyright and/or trademark infringement resulting directly from Licensee's use of the Licensed Technology in the manufacture and sale of the Products and (2) for product liability directly relating to the licensed technology. This indemnity does not extend to claims of infringement arising from combinations of the Licensed Technology with Licensee's technology or Licensee's modifications to the Licensed Technology. ARTICLE XII Disclaimer, Warranty and Limitation of Liability: Except as expressly set forth in this agreement, Licensor disclaims any and all promises, representations and warranties with respect to the Licensed Technology, including its condition, conformity to any representation or description, the existence of any latent or patent defects therein and its merchantability or fitness for a particular use or purpose. ARTICLE XIII Ownership of Licensed Technology. Licensor represents that it is the exclusive owner by assignment from the inventors and its 10 11 employees of the Licensed Technology, that it has the right to grant the License herein granted, and that prior to the effective date of this agreement, it has not granted, nor is it under any obligation to grant, any person or party any right, license, shopright or privilege under the Licensed Technology ARTICLE XIV Trademarks: Except for purposes of descriptively identifying the Licensed Technology, no right, title, interest or license to any trademark or service mark of Licensor is granted to Licensee. ARTICLE XV Relationship Between the Parties: Licensor and Licensee are and shall remain independent contractors and nothing herein shall create a partnership or joint venture between Licensor and Licensee. ARTICLE XVI Advertising, Publicity and Publications: A. Except as otherwise provided herein, Licensee shall not use the names of Litton Systems, Inc. or Litton Industries, Inc. or any of their respective affiliates or divisions in any advertisement or sales materials without the prior written consent of Licensor. B. In any publication (including advertisements, sales and trade literature and instruction manuals) relating to the Licensed Technology used pursuant to this agreement, Licensee shall give due credit to Licensor as owner and Licensor of the Licensed Technology. ARTICLE XVII Term and Termination: A. This agreement shall commence on the stated effective date of this agreement and shall 11 12 continue until the expiration of the last expiring patent covering any of the Licensed Technology licensed hereunder or the cessation of use of the Proprietary Information by Licensee, whichever is later. Notwithstanding the foregoing the obligations of the parties under Article VII, XI and XII shall survive any termination of this agreement. B. In the event of the breach of a material obligation hereunder by either party, the nonbreaching party shall inform the alleged breaching party of said breach in writing. The alleged breaching party shall have thirty (30) days from the date of said notification during which time to cure the breach. In the event the alleged breaching party does not cure the breach within thirty (30) days, the nonbreaching party may terminate this agreement. C. In the event the aforementioned Product Design Agreement is terminated for any of the reasons fisted in Article VIII of that agreement, either party shall have the option to terminate this agreement. However, any of the sums due Licensor under Article III upon the date of termination shall be paid to Licensor within thirty (30) days after such termination. D. Licensee shall within thirty (30) days of termination of this agreement for any reason deliver to Licensor all written documentation in the possession of Licensee which contains Proprietary Information pertaining to the Licensed Technology. ARTICLE XVIII Tooling and Supplies: A. Licensor shall manufacture and sell any pressure intensifiers (boost pumps) required for the Products to Licensee on an exclusive basis for the Field of Use within the Territory. B. Licensor shall sell to Licensee on a nonexclusive basis and Licensee shall buy from Licensor its requirements for oxygen monitors for the Products. C. Licensor shall retain ownership of the tooling for the aforementioned pressure intensifiers. However, Licensee will purchase and retain ownership of any remaining tooling required for the manufacture of the Product. 12 13 D. In the event that Licensor is unable or unwilling to supply Licensee's requirements for pressure intensifiers (boost pumps) and oxygen monitors. Licensor shall sell to Licensee the aforesaid tooling and technical information (specifications, material lists, vendor lists, assembly instructions and the like) necessary to manufacture the pressure intensifiers or oxygen monitors at Licensors then fair market value, not to exceed $250,000.00, for said tooling and technical information. Said tooling and technical information shall only be utilized by licensee to manufacture the products. ARTICLE XIX Notices: All notices required or permitted under this agreement shall be in writing and shall be delivered personally or sent by certified registered mail to Licensee or Licensor at the addresses set forth below. To Licensor: To Licensee: P.O. Box 4508 9445 De Soto Avenue 2734 Hickory Grove Road Chatsworth, California 91311 Davenport, Iowa 52808-4508 ARTICLE XX Waiver: Waiver by either party of any term or provision of this agreement shall not constitute a continuing waiver thereof nor of any further or additional rights such party may hold under this agreement. 13 14 ARTICLE XXI Severability: If any provision of the agreement shall be held to be invalid, illegal or unenforceable, the validity, legality or unenforceability of the remaining provisions shall not in any way be affected or impaired. ARTICLE XXII Governing Law and Disputes: A. This agreement shall be construed in accordance with the laws of the State of Iowa, with the exception of its rules on the conflicts of laws. B. Any disputes arising under this and/or the Product Design Agreement shall be decided by arbitration in accordance with the rules of the American Arbitration Association. Each party shall appoint an arbitrator, and the two, thus selected, shall appoint a third. If either party fails to appoint an arbitrator within sixty (60) days after receipt of the notice from the other party of its appointment of an arbitrator, or if the arbitrators fail to appoint a third, the appointment(s) shall be made by the President of the American Arbitration Association or his designee. The arbitration will be held as promptly as possible at a time and place determined by the arbitrators. The decision of a majority of the arbitrators shall be final and binding upon the parties hereto, and the expense of the arbitration shall be shared equally by the parties. Judgement upon the award can be entered in any court having jurisdiction, or application can be made to such court for a judicial acceptance of the award and an order of enforcement, as the case may be. 14 15 ARTICLE XXIII Miscellaneous: A. This agreement along with the Product Design Agreement are the complete and exclusive statements between the parties relating to the subject matter hereof, and supersedes all prior understandings, communications or representations, either oral or written between the parties. This license agreement may not be modified or altered except by a written instrument duly executed by the parties hereto. B. Subject to this paragraph, the license is personal to Licensee. It is expressly understood that this agreement may not be assigned by either party without the prior written consent of the other. C. This agreement shall bind and entire to the benefit of the parties hereto and their respective successors and permitted assigns, but nothing contained herein shall be deemed to permit assignment by either party except as otherwise permitted in this agreement. D. Neither party shall be held in breach of this agreement because of acts or omissions caused by any act of God or other cause beyond the control of the parties including but not limited to fire, floods, labor disputes or other unforeseen circumstances. IN WITNESS WHEREOF the parties have set their hands and seals and duly executed this agreement effective as of the date first written above. Litton Systems, Inc. Chad Therapeutics, Inc. Life Support Division By /s/ JOHN J. HEFFERNAN By /s/ CHARLES R. ADAMS ------------------------ ------------------------ Title Pres. Title CEO --------------------- --------------------- Date 5-31-96 Date 5-31-96 ---------------------- ---------------------- 15 16 FIRST AMENDMENT TO LICENSE AGREEMENT This First Amendment to the License Agreement (the "License First Amendment") is entered into and made effective as of the 3 day of September, 1996 by and between the Life Support Division of Litton Systems, Inc., a Delaware corporation, having its address at 2734 Hickory Grove Road, PO Box 4508, Davenport, Iowa 52808 (hereinafter referred to as "Licensor") and Chad Therapeutic, Inc., a California corporation having its address at 9445 DeSoto Avenue, Chatsworth, California 91311 (hereinafter referred to as "Licensee"), and hereinafter collectively referred to as "Parties" and individually as "Party". RECITALS WHEREAS, Litton and Chad entered into a License Agreement having an effective date of April 16, 1996 (hereinafter the "License Agreement") for the design by Litton of a Home Oxygen Concentrator and Cylinder Charging System (referred to in the License Agreement as "Product" or "Device"); and WHEREAS, the Parties desire to amend the terms of the License Agreement as set forth herein; NOW, THEREFORE, in consideration of the foregoing premises, the mutual promises contained herein and other good and valuable consideration, the receipt of which is hereby acknowledged, and intending to be legally bound hereby, Licensor and Licensee hereby agree to amend the License Agreement as follows: 1. The term "Licensed Technology" shall be amended by the addition of the following to the end of the definition: "Licensed Technology shall also include all technical information, computer software, trade secrets and related intellectual property, including, without limitation, patented technology, covering the Oxygen Monitor and Test Equipment and related manufacturing technology to be developed by Licensor and disclosed to Licensee under the terms of the First Amendment to the Product Design Agreement. 2. All other terms and conditions of the License Agreement shall remain in full force and effect and shall cover the reciprocal obligations of the parties to the extent that they have been modified by this First Amendment. 1 17 IN WITNESS WHEREOF, the Parties have set their hands and seals and duly executed this License First Amendment effective as of the date first written above. Litton Systems, Inc. Life Support Division By:/s/ JOHN J. HEFFERNAN ----------------------------- John J. Heffernan Title: President - Litton Life Support Division Chad Therapeutic Inc. By:/s/ CHARLES R. ADAMS ----------------------------- Charles R. Adams Title: Chairman, CEO 2 18 SECOND AMENDMENT TO LICENSE AGREEMENT This Second Amendment to the License Agreement (the "License Second Amendment") is entered into and made effective as of the 7 day of November 1996 by and between the Life Support Division of Litton Systems, Inc., a Delaware corporation, having its address at 2734 Hickory Grove Road, PO Box 4508, Davenport, Iowa 52808 (hereinafter referred to as "Licensor") and Chad Therapeutic, Inc., a California corporation having its address at 9445 DeSoto Avenue, Chatsworth, California 91311 (hereinafter referred to as "Licensee"), and hereinafter collectively referred to as "Parties" and individually as "Party". RECITALS WHEREAS, Litton and Chad entered into a License Agreement having an effective date of April 16, 1996 (hereinafter the "License Agreement") for the design by Litton of a Home Oxygen Concentrator and Cylinder Charging System (referred to in the License Agreement as "Product" or "Device"); and WHEREAS, the parties entered into a First Amendment to the License Agreement; and WHEREAS, THE Parties desire to further amend the terms of the License Agreement as set forth herein; NOW, THEREFORE, in consideration of the foregoing premises, the mutual promises contained herein and other good and valuable consideration, the receipt of which is hereby acknowledged, and intending to be legally bound hereby, Licensor and Licensee hereby agree to amend the License Agreement as follows: 1. The term "Licensed Technology" shall be amended by the addition of the following to the end of the definition: "Licensed Technology shall also include all technical information, computer software, trade secrets and related intellectual property, including, without limitation, patented technology, covering the High Pressure Fill Port and Pressure Vessel Flow Controller and related manufacturing technology to be developed by Licensor and disclosed to Licensee under the terms of this Second Amendment to the Product Design Agreement. 1 19 2. All other terms and conditions of the License Agreement shall remain in full force and effect and shall cover the reciprocal obligations of the parties to the extent that they have been modified by the Second Amendment. 3. In addition to the Licensed Technology statements, the "Product" definition in Article 1, section B of the License Agreement shall be modified to reflect the project changes which have transpired since the FDA meeting in July, 1996. The product name, Chad Total Oxygen Delivery System, indicates that the Product has evolved from an oxygen concentrator to an oxygen delivery system. The "Product" definition shall be modified to include all of the components packaged by Chad which make up the "System" that are the results of the Litton design effort described under the Product Design Agreement and its amendments. As of the effective date of the License Second Amendment, these components include the CTODS oxygen concentrator and all portable oxygen cylinders equipped with the pressure vessel flow control valve (Special Fitting). The terms of the License Agreement shall govern all portable oxygen cylinders equipped with the pressure vessel flow control valve (Special Fitting) regardless of whether they are sold with the "System" or sold separately. IN WITNESS WHEREOF, the Parties have set their hands and seals and duly executed this License Second Amendment effective as of the date first written above. Litton Systems, Inc. Life Support Division By: /s/ JOHN J. HEFFERNAN ------------------------------- John J. Heffernan Title: President - Litton Life Support Division Chad Therapeutic Inc, By: /s/ CHARLES R. ADAMS ------------------------------- Charles R. Adams Title: Chairman, CEO 2 20 THIRD AMENDMENT TO LICENSE AGREEMENT This Third Amendment to the License Agreement (the "License Third Amendment") is entered into and made effective as of the 15 day of October, 1997 by and between the Life Support Division of Litton Systems, Inc., a Delaware corporation, having its address at 2734 Hickory Grove Road, P.O. Box 4508, Davenport, Iowa 52808 (hereinafter referred to as "Licensor") and Chad Therapeutic, Inc., a California corporation having its address at 21622 Plummer Street, Chatsworth, California 91311 (hereinafter referred to as "Licensee"), and hereinafter collectively referred to as "Parties" and individually as "Party". RECITALS WHEREAS, Litton and Chad entered into a License Agreement having an effective date of April 16, 1996 (hereinafter the "License Agreement") for the design by Litton of a Home Oxygen Concentrator and Cylinder Charging System (referred to in the License Agreement as "Product" or "Device"); and WHEREAS, the parties entered into a First Amendment to the License Agreement having an effective date of September 3,1996 and a Second Amendment to the License Agreement having an effective date of October 29, 1996; and WHEREAS, the parties desire to further amend the terms of the License Agreement as set forth herein; NOW, THEREFORE, in consideration of the foregoing premises, the mutual promises contained herein and other good and valuable consideration, the receipt of which is hereby acknowledged, and intending to be legally bound hereby, Licensor and Licensee hereby agree to amend the License Agreement and the amendments thereto referenced above as follows: 1. Licensor hereby grants to Licensee an option to obtain an exclusive, non-transferable, royalty-bearing license with a right of sublicense to make, use and sell Products in the Field of Use in Japan, China, Taiwan, Korea, Hong Kong, Singapore and Malaysia (hereinafter the "Option"). 21 2. The Option shall be exercisable by Licensee from the effective date of this License Third Amendment through December 31, 1999, after which time the Option shall expire. 3. If Licensor exercises the Option, then Licensee shall pay Licensor the following sums: (a) Licensee shall pay Licensor the sum of $100,000 within ten business days after Licensee notifies Licensor of its exercise of the Option; and (b) Licensee shall pay Licensor a second sum of $100,000 twelve months after the date on which Licensee has notified Licensor of its exercise of the Option. 4. As further consideration for the grant of said Option, Licensee shall pay to Licensor royalties at the rate of four percent (4%) of the Net Selling Price of Products sold or leased by Licensee or any sublicensee in China, Taiwan, Korea, Hong Kong, Singapore or Malaysia. For sales of Products in Japan, Licensee shall pay to Licensor a royalty at the rate of six percent (6%) of the Net Selling Price of Products sold in Japan by Licensee or a sublicensee. 5. In consideration of Licensor deferring its right to make use of the Licensed Technology in Japan, China, Taiwan, Korea, Hong Kong, Singapore or Malaysia during the time that the Option is available for exercise by Licensee, Licensee shall pay to Licensor the sum of $50,000 on or before January 31, 2000 if Licensee does not exercise the Option within the time period set forth in Paragraph 2 herein. IN WITNESS WHEREOF, the Parties have set their hands and seals and duly executed this License Third Amendment effective as of the date first written above. LITTON SYSTEMS, INC. CHAD THERAPEUTIC, INC. LIFE SUPPORT DIVISION By: /s/ JOHN J. HEFFERNAN By: /s/ CHARLES R. ADAMS ------------------------------- ------------------------------- John J. Heffernan, President Charles R. Adams Litton Life Support Division Chairman, CEO EX-13.1 3 EXHIBIT 13.1 1 EXHIBIT 13.1 [PHOTOGRAPH OF CHAIRMAN] Charles R. Adams Chairman of the Board LETTER FROM THE CHAIRMAN For the past seven years or more it has been a personal pleasure to write this opening paragraph. I was able to report phenomenal success and growth in both sales and earnings and the establishment of many new records each year. That is not the case for fiscal 1998 as both sales and earnings declined significantly. While it was a disappointing year in terms of our financial performance, we remain in solid financial condition and progress is being made towards regaining our growth pattern. I will let Tom Jones, your new Chief Executive Officer, review plans and the outlook for the future in his letter to you which follows and I will attempt to review the events and causes of the difficult year just concluded. During much of calendar year 1997 discussions and negotiations were being held as the federal government tried to achieve a balanced budget. As these negotiations took place rumors became rampant regarding the size of the proposed reduction in reimbursement for home oxygen services by Medicare, with some estimates as high as 40%. This had a significant impact on home oxygen providers all over the country in two major ways. Providers reduced spending as much as possible as they scrambled to minimize costs and expenses; and they became seriously concerned about their ability to survive in business with these proposed drastic reductions. The final budget bill enacted in the fall included a 25% cut in home oxygen reimbursement, which went into effect on January 1, 1998, with an additional 5% cut to become effective January 1, 1999. As a result providers continued their efforts to reduce expenses. In Chad's area of portable oxygen, many took drastic measures and reverted to the methods of ten or more years ago, substituting the old large bulky cylinders and carts for more modern and truly ambulatory systems. Another impact of the turmoil over reimbursement cuts was the increase in consolidation activity that resulted in strong independent dealers being acquired by large national chains. Independents have been, by far, the largest and most important part of Chad's business. Chad's independent dealers have also been the most attractive acquisitions for the national chains because of 2 their growth and profitability, due in large part to Chad's efficient and desirable systems. The loss of these dependable customers as they complied with the purchasing policies of their new owners was a substantial loss to Chad. The Company also faced a form of competition that had heretofore not manifested itself. There had been competition in the oxygen conserving device market for several years but it had never been serious. There was no other electronic conserver that could compete with Chad's OXYMATIC conserver because of its clearly superior oxygen savings efficiency. We had always argued that the only logical reason for using an oxygen conserving device was to conserve as much oxygen as possible. Chad's OXYMATIC conserver provided an average savings ratio of seven to one compared with competitive devices three to one savings at best. However, the first half of fiscal 1998 brought several new conserving devices to the market with all of them competing on the basis of unit cost of the device. They accomplished something I never would have believed possible. They successfully got a number of physicians, therapists and providers to think of oxygen conservers as generic products without regard to efficiency. Consequently, the market became more unit price sensitive and cheaper electronic conservers captured some of the loyal market we had built over the years. The good news is that despite the loss in market share in the past year the OXYMATIC conserver is still the market leader and recent indications are that unit sales of this product are on the rise again as providers are learning to cope with the reimbursement cuts. During this time the Company was working to complete development of the new TOTAL 0[subscript]2(TM) Delivery System. It promises to be the right product at the right time for both the Company and the home oxygen industry. The TOTAL 0[subscript]2 system provides stationary oxygen for the patient at home, portable oxygen including an oxygen conserving device for ambulation and a safe efficient mechanism to fill the portable unit from the stationary unit. It can improve providers' profitability by reducing the cost of servicing patients while at the same time delivering a higher quality of service to those patients as they are no longer restricted in the amount of ambulatory oxygen they can use. Truly the right product at the right TIME. The Company previewed the new product in early October at the Medtrade show in New Orleans to great enthusiasm. However, it was not ready to sell as clearance was not received from the FDA until mid-November and shipping did not begin until January as the Company and its suppliers refined manufacturing practices for the new system. Manufacturing processes are still being refined as the Company works to increase production capability of the TOTAL 0[subscript]2 system. We did ship $535,000 in TOTAL 0[subscript]2 systems through March 31, 1998, and had a $361,000 backlog of systems at that date. Tom Jones will review expectations for the new product in his report, including the product's international potential. I certainly would have much preferred a different outcome for this, my last year as Chad's CEO. Even so, I still feel very good and increasingly optimistic about the Company's future with the opportunities we have and Tom Jones to lead us. I wouldn't trade my experiences of the past 16 years and my wonderful associations for anything. That includes not only Chad management and employees but the many loyal friends who have invested in Chad. Although I'm no longer a part of management, as Chairman of the Board I would like to promise you once again that we will all do our very best. Charles R. Adams /s/ CHARLES R. ADAMS Chairman of the Board of Directors 5 3 [PHOTOGRAPH OF CEO] Thomas E. Jones Chief Executive Officer I am pleased to be able to write to you as your new Chief Executive Officer. While the respiratory care industry faces many challenges today I am excited about the opportunities the Company currently has before it and look forward to working with the people at Chad to achieve the Company's potential. After the shock of experiencing the reality of a 25% across the board Medicare oxygen revenue reduction (effective January 1, 1998), our home care provider customers, we believe, are rolling up their sleeves and going about the tasks of re-engineering their businesses to absorb this revenue reduction as well as the 5% reduction scheduled for January 1, 1999. For the most part, they also recognize that these revenue cuts will not be the end of the cost reduction pressure in the health care arena. The Competitive Bidding study mandated by Congress is only one example of further pricing pressure. With this atmosphere in mind, I cannot envision a more appropriate time to be offering a product such as the Total 0[subscript]2"(TM) Delivery System. Not only is the reimbursement structure forcing home care providers to learn how to deliver oxygen to home care patients more efficiently, but the growth of the home oxygen patient base, driven by chronic obstructive pulmonary disease (COPD), continues at about 8-10% annually by most estimates. From our perspective the clinical advantages of ambulatory oxygen for the increasingly mobile patient population continues to align the market characteristics in favor of innovative lower total cost home oxygen patient solutions, such as the Total 0[subscript]2 system. The adoption of the Total 0[subscript]2 system lends itself to those home care providers who want to and are willing to technologically leapfrog their competition to achieve lower costs and a higher quality of service for ambulatory patients. Some home care providers who wish to try to incrementally squeeze their costs to regain acceptable profitability in the face of Medicare revenue cuts are very reluctant to adopt a new technology such as the Total 0[subscript]2 system, which requires changes in various operating 4 approaches such as rationalizing or eliminating truck delivery schedules. However, for those providers willing to "think outside the box" and restructure their businesses, we believe the rewards will be great. For several of our "early adopters" of the Total 0[subscript]2 system, the rewards appear to be very significant in achieving lower operating costs, increasing market share and improving patient satisfaction. Several of these "early adopter" accounts are having excellent success directing media ads at patients through Chad's co-op advertising program to gain market share. The U.S. market for home oxygen systems is generally estimated to be in the area of $250-$300 million with unit volume of oxygen systems at 250-300 thousand for calendar 1997. With the non-U.S. market adding approximately 25% to those U.S. numbers, the size of the opportunity for Chad is enormous even when one accounts for the non-ambulatory patients who have been built into these base estimates. With so large a market opportunity before us we are currently exploring various methods of achieving more effective sales efforts including utilizing some form of field sales organization to provide face-to-face sales representatives to sell the Total 0[subscript]2 system to home care providers. We would expect to come to some conclusion and have a plan implemented by the time you receive this Annual Report. After the sharp erosion of our market share in the traditional OXYMATIC conserver product line during fiscal 1998, we believe this profitable line is beginning to grow again. We believe this is due to both regaining some historical customers as well as the expanding market discussed earlier combined with home care providers search for the most cost efficient products to deal with the recent Medicare reimbursement cuts. In the International arena, we can tell you that interest in the Total 0[subscript]2 system is high. Converting this interest to sales revenues will however take time and much effort due to both the necessary regulatory approvals as well as the various reimbursement structures outside the U.S. which, in some cases, do not necessarily favor cost reductions for home oxygen delivery. Cost reduction pressures are however, consistent in virtually every venue, so most foreign health care systems are examining ways to reduce healthcare costs over time. We are nevertheless pursuing regulatory approval in numerous foreign venues. In some countries we, along with our selected distributors, may need to pursue modifications of drug delivery regulations to allow delivery of 93% oxygen via compressed gas cylinders. We do however anticipate modest but growing revenue during fiscal 1999 for the Total 0[subscript]2 system. With regard to the traditional OXYMATIC conserver and related products, we anticipate some recovery from fiscal 1998. However, significant growth and penetration in international markets is not expected until the regulatory approvals are received for the Total 0[subscript]2 system. For this coming year, Chad's focus will be on the following objectives: - To achieve smooth and efficient Total 0[subscript]2 system manufacturing operations with the ability and plan to expand manufacturing volume as necessary - To achieve sales and market penetration in the U.S. consistent with the large opportunities that the current market conditions offer - To continue preparation for introduction of the Total 0[subscript]2 system to international markets, and - To pursue and develop the new product opportunities which we have before us These objectives will certainly challenge everyone within the Chad team. However, I have no doubt that these things can be accomplished with the outstanding group of fellow employees here at Chad. Thomas E. Jones /s/ THOMAS E. JONES Chief Executive Officer 7 5 ISO 9000 CERTIFICATION CHAD RECEIVES ISO 9000 CERTIFICATION AND CE MARK By: Louie Goryoka, Vice President Quality Assurance and Regulatory Affairs [PHOTOGRAPH OF VICE PRESIDENT QUALITY ASSURANCE] Louie Goryoka Vice President Quality Assurance and Regulatory Affairs One of the most significant changes in domestic and international business is the recent movement toward quality awareness. The importance of quality and reliability is becoming recognized as a critical factor for the sale of many products and services. This growth in international quality awareness has resulted in customer and consumer demand for products and services that are entirely suitable for the purpose intended. Furthermore, there is a growing expectation that products distributed internationally will continue to be operational and serviceable for an acceptable period of time. The international standards for meeting these quality goals are ISO 9000 certification and CE marking of products and Chad Therapeutics has recently been approved for both of these standards. In pursuit of an increasingly successful role in the global economy Chad has been constantly improving its quality system to meet or exceed these standards. Thus, as Chad's quality system moves through improvement phases, so does the Company's opportunity for success in the competitive global marketplace. With the ISO 9000 certification Chad is improving efficiency, reducing costs and most importantly increasing customer satisfaction. The CE Marking is the manufacturer's self-declaration, showing compliance with all applicable EC directives. For most products sold in the European Union (EU), the use of the CE Marking and the Declaration of Conformity are mandatory as of June 1998. With this mark of conformity, Chad's products can be marketed freely throughout the member countries. In today's marketplace there are many benefits resulting from ISO 9000 certification and CE Marking of products. Chad Therapeutics is committed to maintaining the highest possible quality standards so that our products are in the best possible competitive position. 8 6 FINANCIAL HIGHLIGHTS SELECTED FINANCIAL DATA
YEARS ENDED MARCH 31, ----------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ----------- ---------- ---------- ---------- --------- Net Sales $16,593,000 26,161,000 20,359,000 14,518,000 9,470,000 Interest Income 164,000 113,000 97,000 50,000 28,000 Net Earnings 797,000 5,035,000 4,310,000 2,606,000 2,053,000 Basic Earnings Per Share .08 .51 .44 .26 .20 Diluted Earnings Per Share .08 .49 .42 .26 .20 Net Working Capital 10,704,000 10,985,000 9,219,000 5,172,000 4,176,000 Total Assets 17,436,000 15,861,000 10,778,000 6,371,000 5,075,000 Shareholders' Equity 16,074,000 15,110,000 9,775,000 5,574,000 4,507,000
No cash dividends have been declared or paid during the periods presented. 9 7 BALANCE SHEETS
MARCH 31, -------------------------------- 1998 1997 ------------ ---------- ASSETS Current assets: Cash $ 1,579,000 2,289,000 Accounts receivable, less allowance for doubtful accounts of $105,000 and $107,000 in 1998 and 1997 2,469,000 2,329,000 Inventories (Note 2) 7,133,000 6,063,000 Income taxes refundable (Note 3) 572,000 527,000 Prepaid expenses 249,000 172,000 Deferred income taxes (Note 3) 64,000 356,000 ------------ ---------- Total current assets 12,066,000 11,736,000 ------------ ---------- Property and equipment, at cost: Office equipment and furniture 1,639,000 1,265,000 Machinery and equipment 804,000 634,000 Tooling 1,084,000 305,000 Leasehold improvements 1,748,000 1,640,000 ------------ ---------- 5,275,000 3,844,000 Less accumulated depreciation and amortization 1,310,000 717,000 ------------ ---------- Net property and equipment 3,965,000 3,127,000 ------------ ---------- Note receivable from related party (Note 4) 126,000 -- Other assets, net (Note 5) 1,279,000 998,000 ------------ ---------- $ 17,436,000 15,861,000 ============ ==========
1998 1997 ------------ --------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 730,000 344,000 Accrued expenses (Note 8) 632,000 407,000 ------------ --------- Total current liabilities 1,362,000 751,000 ------------ --------- Commitments (Note 9) Shareholders' equity (Note 6): Common shares Authorized 40,000,000 shares; 10,008,000 and 9,951,000 shares issued 13,100,000 12,834,000 Retained earnings 3,105,000 2,308,000 ------------ ---------- 16,205,000 15,142,000 Less treasury shares at cost, 19,000 and 3,000 shares in 1998 and 1997 (131,000) (32,000) ------------ ---------- Net shareholders' equity 16,074,000 15,110,000 ------------ ---------- $ 17,436,000 15,861,000 ============ ==========
See accompanying notes to financial statements. 8 STATEMENTS OF EARNINGS
YEARS ENDED MARCH 31, ----------------------------------------------- 1998 1997 1996 ----------- ---------- ---------- Net sales $16,593,000 26,161,000 20,359,000 Cost of sales 8,670,000 11,356,000 8,480,000 ----------- ---------- ---------- Gross profit 7,923,000 14,805,000 11,879,000 Costs and expenses: Selling, general and administrative 6,042,000 5,595,000 4,791,000 Research and development 713,000 910,000 113,000 ----------- ---------- ---------- Total costs and expenses 6,755,000 6,505,000 4,904,000 ----------- ---------- ---------- Operating income 1,168,000 8,300,000 6,975,000 Interest income 164,000 113,000 97,000 ----------- ---------- ---------- Earnings before income taxes 1,332,000 8,413,000 7,072,000 Income taxes (Note 3) 535,000 3,378,000 2,762,000 ----------- ---------- ---------- Net earnings $ 797,000 5,035,000 4,310,000 =========== ========== ========== Basic earnings per share $ .08 .51 .44 =========== ========== ========== Diluted earnings per share $ .08 .49 .42 =========== ========== ==========
See accompanying notes to financial statements. 9 STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED MARCH 31,1998,1997 AND 1996
RETAINED COMMON SHARES (NOTE 6) EARNINGS ------------------------------- (ACCUMULATED TREASURY SHARES AMOUNT DEFICIT) SHARES ------------ ------------ ------------ ------------- Balance at March 31, 1995 9,620,000 $ 6,832,000 (1,258,000) $ -- Common Shares Repurchased and Retired (71,000) (392,000) -- -- Common Shares Repurchased At Cost -- (228,000) -- -- Common Shares Issued For Purchases Under Employee Benefit Plan -- -- -- 160,000 Exercise of Stock Options 74,000 187,000 -- -- Tax Benefit From Exercise of Non-Qualified Stock Options -- 164,000 -- -- Net Earnings -- -- 4,310,000 -- ---------- ------------ ------------ ------------ Balance at March 31, 1996 9,623,000 6,791,000 3,052,000 (68,000) Common Shares Repurchased At Cost -- -- -- (183,000) Common Shares Issued For Purchases Under Employee Benefit Plan -- 5,000 -- 219,000 3% Stock Dividend 289,000 5,779,000 (5,779,000) -- Exercise of Stock Options 41,000 216,000 -- -- Common Shares Tendered and Retired For Stock Option Exercise (2,000) (32,000) -- -- Tax Benefit From Exercise of Non-Qualified Stock Options -- 75,000 -- -- Net Earnings -- -- 5,035,000 -- ---------- ------------ ------------ ------------ Balance at March 31, 1997 9,951,000 12,834,000 2,308,000 (32,000) Common Shares Repurchased At Cost -- -- -- (285,000) Common Shares Issued For Purchases Under Employee Benefit Plan -- -- -- 186,000 Exercise of Stock Options 57,000 156,000 -- -- Tax Benefit From Exercise of Non-Qualified Stock Options -- 103,000 -- -- Stock Option Grants -- 7,000 -- -- Net Earnings -- -- 797,000 -- ---------- ------------ ------------ ------------ Balance at March 31, 1998 10,008,000 $ 13,100,000 $ 3,105,000 $ (131,000) ========== ============ ============ ============
See accompanying notes to financial statements. 12 10 STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH YEARS ENDED March 31, ------------------------------------------------- 1998 1997 1996 ----------- --------- --------- Cash flows from operating activities: Net earnings $ 797,000 5,035,000 4,310,000 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 617,000 280,000 114,000 Compensation expense related to option grants 7,000 -- -- Changes in assets and liabilities: Decrease (increase) in accounts receivable (140,000) 543,000 (746,000) Decrease (increase) in inventories (1,070,000) (2,052,000) (2,166,000) Decrease (increase) in income taxes refundable (45,000) (527,000) 84,000 Decrease (increase) in prepaid expenses (77,000) (27,000) (20,000) Decrease (increase) in deferred income taxes 292,000 -- (202,000) Decrease (increase) in note receivable from related party (126,000) -- -- Decrease (increase) in other assets (305,000) (942,000) -- Increase (decrease) in accounts payable 386,000 (55,000) (115,000) Increase (decrease) in accrued expenses 225,000 (17,000) (141,000) Increase (decrease) in income taxes payable -- (180,000) 180,000 ----------- --------- --------- Net cash provided by operating activities 561,000 2,058,000 1,580,000 ----------- --------- --------- Cash flows from investing activities: Decrease (increase) in marketable securities -- 1,029,000 (613,000) Capital expenditures (1,431,000) (2,912,000) (268,000) Dispositions of property and equipment -- 5,000 -- ----------- --------- --------- Net cash (used in) investing activities (1,431,000) (1,878,000) (881,000) ----------- --------- --------- Cash flows from financing activities: Tax benefit from exercise of non-qualified stock options 103,000 75,000 164,000 Exercise of stock options 156,000 216,000 187,000 Common shares purchased (285,000) (183,000) (620,000) Common shares issued 186,000 224,000 160,000 Common shares tendered and retired -- (32,000) -- ----------- --------- --------- Net cash provided by (used in) financing activities 160,000 300,000 (109,000) ----------- --------- --------- Net increase (decrease) in cash (710,000) 480,000 590,000 Cash beginning of year 2,289,000 1,809,000 1,219,000 ----------- --------- --------- Cash end of year $ 1,579,000 2,289,000 1,809,000 =========== ========= ========= Supplemental disclosure of cash flow information: Cash paid during the year for: Income taxes $ 185,000 4,010,000 2,535,000 =========== ========= ========= Supplemental schedule of noncash investing and financing activities: Common stock issued as payment of dividend $ -- 5,779,000 -- =========== ========= =========
See accompanying notes to financial statements. 13 11 NOTES TO FINANCIAL STATEMENTS MARCH 31, 1998 (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, 1998. The carrying amounts related to cash, accounts receivable, other current assets, accounts payable and accrued expenses approximate fair value due to the relatively short maturity of such instruments. It is not practicable to estimate the fair value of the note receivable from related party due to the nature of the instrument. INVENTORIES Inventories are valued at lower of cost or market. Cost is determined based on standard cost which approximates the first-in, first-out method. DEPRECIATION Depreciation of property and equipment is provided using straight-line methods based on the estimated useful lives of the related assets as follows: Office Equipment and Furniture 5-7 Years Machinery and Equipment 5-10 Years Tooling 3 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 generally accepted accounting principles. Actual results could differ from those estimates. REVENUE RECOGNITION Revenue from product sales is recognized upon shipment of merchandise. NET EARNINGS PER COMMON SHARE The Financial Accounting Standards Board issued Statement No. 128, "Earnings Per Share ("FAS 128"), in February 1997. FAS 128 is effective for both interim and annual periods ending after December 1997. FAS 128 requires the presentation of "Basic" earnings per share which represents income available to common shareholders divided by the weighted average number of common shares outstanding for the period. A dual presentation of "Diluted" earnings per share is also required. The adoption of FAS 128 did not have a material impact on the Company's financial position or results of operations. Following is a reconciliation of the numerators and denominators used in the calculation of basic and diluted net earnings per common share for the years ended March 31, 1998, 1997 and 1996, respectively:
1998 1997 1996 ----------- ----------- ----------- Basic net earnings per share Numerator - net earnings $ 797,000 5,035,000 4,310,000 Denominator - common shares outstanding 9,958,000 9,931,000 9,853,000 ----------- ----------- ----------- Basic net earnings per share $ .08 $ .51 $ .44 =========== =========== =========== Diluted net earnings per share Numerator - net earnings $ 797,000 5,035,00 4,310,000 Denominator - Common shares outstanding 9,958,000 9,931,000 9,853,000 Common stock options 256,000 442,000 367,000 ----------- ----------- ----------- 10,214,000 10,373,000 10,220,000 ----------- ----------- ----------- Diluted net earnings per share $ .08 $ .49 $ .42 =========== =========== ===========
Options to purchase 407,000 shares of common stock at prices ranging from $9.75 to $13.471 per share were not included in the computation of diluted earnings per share in 1998 because the option price was greater than the average market price of the common shares. All of the share, per share and weighted average number of shares have been retroactively adjusted for a three-for-two stock split distributed on October 16, 1995, to all shareholders of record on October 2, 1995. In addition, the weighted average number of shares has been adjusted for a 3% stock dividend paid on October 15, 1996, to shareholders of record on October 1, 1996, which resulted in the issuance of 289,000 new shares. RESEARCH AND DEVELOPMENT COSTS The Company charges all research and development costs to expense when incurred. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The 14 12 effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enacted date. MAJOR CUSTOMER The Company had sales to one major customer which accounted for approximately 11% and 18% of net sales during the years ended March 31, 1998 and 1997, respectively. No one customer exceeded 10% of net sales during 1996. RECLASSIFICATIONS Certain reclassifications have been made to the prior year's balances to conform to the 1998 presentation. STOCK OPTION PLAN Prior to April 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of the grant only if the current market price of the underlying stock exceeded the exercise price. On April 1, 1996, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. NEWLY ISSUED ACCOUNTING STANDARDS The Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income" ("FAS 130"), in June 1997. FAS 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. FAS 130 is effective for both interim and annual periods beginning after December 15, 1997. The Company will adopt FAS 130 in the first quarter of the fiscal year ending March 31, 1999. Management believes that the adoption of FAS 130 will not have a material impact on the Company's financial position or results of operations. The Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131"), in June 1997. FAS 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. It replaces the "industry segment" concept of FAS No. 14, "Financial Reporting for Segments of a Business Enterprise", with a "management approach" concept as to basis for identifying reportable segments. FAS 131 is effective for financial statements for periods beginning after December 15, 1997. The Company will adopt FAS 131 in the annual financial statements of the fiscal year ending March 31, 1999. Management believes the adoption of FAS 131 will not have a material impact on the Company's financial position or results of operations. (2) INVENTORIES At March 31, 1998 and 1997, inventories consisted of the following:
1998 1997 ---------- --------- Finished goods $1,154,000 1,228,000 Work in process 1,117,000 1,454,000 Raw materials and supplies 4,862,000 3,381,000 ---------- --------- $7,133,000 6,063,000 ========== =========
(3) INCOME TAXES The provision for income taxes for fiscal 1998, 1997 and 1996 consists of the following:
1998 1997 1996 ---------- ---------- ---------- Current: Federal $ 137,000 2,609,000 2,288,000 State 106,000 769,000 676,000 ---------- ---------- ---------- 243,000 3,378,000 2,964,000 Deferred: Federal 274,000 (10,000) (181,000) State 18,000 10,000 (21,000) ---------- ---------- ---------- 292,000 -- (202,000) ---------- ---------- ---------- Total $ 535,000 3,378,000 2,762,000 ========== ========== ==========
A reconciliation of the difference between the Company's provision for income taxes and the statutory income tax for the years ended March 31, 1998, 1997 and 1996, respectively, is as follows:
1998 1997 1996 ---------- ---------- ---------- Statutory tax expense $ 453,000 2,860,000 2,404,000 State income tax 82,000 514,000 432,000 Warranty and other -- 4,000 (74,000) ---------- ---------- ---------- $ 535,000 3,378,000 2,762,000 ========== ========== ==========
15 13 The tax effects of temporary differences a give rise to significant portions of the deferred tax assets at March 31, 1998 and 1997 are presented as follows:
1998 1997 -------- ------- State taxes $ 29,000 265,000 Bad debt reserves 36,000 46,000 Accrued expenses 57,000 36,000 Inventories 23,000 21,000 -------- ------- Total deferred tax assets $145,000 368,000 Deferred tax liability - depreciation (81,000) (12,000) -------- ------- Net deferred tax assets $ 64,000 356,000 ======== =======
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. Based upon the levels of historical taxable income, management believes that it is more likely than not, that the Company will realize the deferred tax assets. As such, no valuation allowance has been recorded. (4) NOTE RECEIVABLE FROM RELATED PARTY The note receivable from related party is due from an officer and is payable in monthly installments of $1,200 with interest at 7.25%, is secured by a second trust deed and is due in April, 2112. (5) OTHER ASSETS Other assets includes $1,250,000 paid in 1997 and 1998 for a license on a new product. The license fee is being amortized beginning in 1998 using the straight-line method over the life of the related patents, 14 years. (6) SHAREHOLDERS' EQUITY In 1998,1997 and 1996 the Company purchased its own stock for purposes of funding contributions to the Company's 401(k) plan. Periodically as common shares are sold to the plan, the difference between the cost and fair market value at the date of transfer is credited to shareholders' equity ($5,000 in 1997). 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, 1995 512,000 $ 2,536,000 4.95 Granted 134,000 1,520,000 11.34 Exercised (38,000) (89,000) 2.34 -------- ----------- ----- Outstanding - March 31, 1996 608,000 3,967,000 6.53 Cancelled (15,000) (117,000) 7.80 Granted -- -- -- Exercised (27,000) (152,000) 5.67 -------- ----------- ----- Outstanding - March 31, 1997 566,000 3,698,000 6.53 Cancelled (30,000) (372,000) 12.40 Granted 254,000 2,492,000 9.81 Exercised (2,000) (10,000) 5.98 -------- ----------- ----- Outstanding - March 31, 1998 788,000 $ 5,808,000 7.37 ======== =========== ===== Exercisable - March 31, 1998 372,000 $ 2,107,000 5.66 ======== =========== ===== Non-qualified Options: Outstanding - March 31, 1995 160,000 $ 526,000 3.29 Granted 62,000 775,000 12.50 Exercised (39,000) (98,000) 2.51 -------- ----------- ----- Outstanding - March 31, 1996 183,000 1,203,000 6.57 Cancelled (3,000) (11,000) 3.93 Granted 16,000 139,000 9.25 Exercised (14,000) (64,000) 4.57 -------- ----------- ----- Outstanding - March 31, 1997 182,000 1,267,000 6.96 Granted 26,000 267,000 10.27 Exercised (55,000) (146,000) 2.66 -------- ----------- ----- Outstanding - March 31, 1998 153,000 $ 1,388,000 9.07 ======== =========== ===== Exercisable - March 31, 1998 123,000 $ 1,111,000 9.03 ======== =========== =====
At March 31, 1998, information regarding outstanding options is summarized as follows: Range of exercise prices $1.68-6.69 8.75-13.47 Number outstanding 519,000 422,000 Weighted average remaining life (yrs.) 6.7 8.9 Weighted average exercise price $ 5.13 $ 10.77 Number exercisable 390,000 105,000 Weighted average exercise price $ 4.56 $ 12.26
16 14 Incentive and non-qualified options were granted at prices not less than 100% of fair market value at dates of grant. Options under the plan become exercisable on the anniversary of the grant date on a prorata basis over a defined period and expire 10 years after the date of grant. To the extent the Company derived a tax benefit from options exercised by employees, such benefit is credited to Common Stock when realized on the Company's income tax returns. The Company applies Accounting Principles Board Opinion No. 25 in accounting for its plan. Accordingly, no compensation expense has been recognized for its stock options in the accompanying financial statements. Had compensation cost for awards under the Company's stock option plan been determined based upon the fair value at the grant date prescribed under Statement of Financial Accounting Standards No. 123, the Company's net earnings in 1998, 1997 and 1996 would have been reduced by approximately $247,000, $214,000 and $100,000, respectively, and net earnings per share would have been reduced by $.02, $.02 and $.01 per share in 1998, 1997 and 1996, respectively. The weighted average fair value of options granted during 1998, 1997 and 1996 is estimated at $5.41, $2.83 and $5.69, respectively. The fair value of options granted during each period was estimated using the Black-Scholes option pricing model with the following assumptions.
1998 1997 1996 ---- ---- ---- Risk-free interest rate 5.9% 5.9% 6.2% Forfeiture rate 2.0% 2.0% 2.0% Dividend yield .0 .0 .0 Volatility 57% 45% 45% Expected life (years) 5.0 5.0 5.0
(7) EMPLOYEE BENEFIT PLAN In December, 1992, the Company adopted a defined contribution profit sharing plan, including features under Section 401(k) of the Internal Revenue Code. The purpose of the plan is to provide an incentive for employees to make regular savings for their retirement. Company contributions to the profit sharing plan are discretionary and are determined by the Board of Directors. The Company has accrued and paid $59,000, $96,000, and $71,000 of the plan contributions during 1998, 1997 and 1996, respectively. (8) ACCRUED EXPENSES Accrued expenses consist of the following:
1998 1997 -------- -------- Accrued royalties $144,000 116,000 Deferred revenue 98,000 -- Product and business liability insurance 41,000 67,000 Deferred rent 92,000 97,000 Accrued vacation 76,000 72,000 Other 181,000 55,000 -------- -------- $632,000 407,000 ======== ========
(9) COMMITMENTS The Company is currently leasing its administrative and plant facilities and certain office equipment under noncancellable operating leases which expire through June, 2003. The Company's minimum annual rental commitments under these leases are as follows: 1999 $ 368,000 2000 356,000 2001 344,000 2002 354,000 2003 368,000 Thereafter 93,000 ---------- TOTAL: $1,883,000 ==========
Rent expense amounted to $440,000, $417,000, and $239,000 for the years ended March 31, 1998, 1997 and 1996, respectively. (10) QUARTERLY FINANCIAL DATA (UNAUDITED) The following table presents summarized unaudited quarterly financial data for 1998 and 1997:
NET BASIC GROSS EARNINGS EARNINGS(LOSS) REVENUE PROFIT (LOSS) PER SHARE ----------- ----------- ----------- -------------- 1998 ---- First Quarter $ 5,428,000 $ 2,985,000 $ 804,000 $0.08 Second Quarter 4,390,000 2,214,000 289,000 0.03 Third Quarter 3,234,000 1,324,000 (286,000) (0.03) Fourth Quarter 3,541,000 1,400,000 (10,000) 0.00 ----------- ----------- ----------- ----- Year $16,593,000 $ 7,923,000 $ 797,000 $0.08 =========== =========== =========== ===== 1997 ---- First Quarter $ 7,772,000 $ 4,593,000 $ 1,624,000 $0.17 Second Quarter 7,357,000 4,257,000 1,610,000 0.16 Third Quarter 5,955,000 3,161,000 1,099,000 0.11 Fourth Quarter 5,077,000 2,794,000 702,000 0.07 ----------- ----------- ----------- ----- Year $26,161,000 $14,805,000 $ 5,035,000 $0.51 =========== =========== =========== =====
(11) SUBSEQUENT EVENT On May 7, 1998, the Company entered into an agreement with it's bank to provide a line of credit for one year of $2,000,000 for working capital to expand the new TOTAL 0[subscript]2 Delivery System product line. Amounts borrowed under the line of credit will bear interest at the bank's prime rate and is payable monthly. 17 15 INDEPENDENT AUDITOR'S REPORT THE BOARD OF DIRECTORS AND SHAREHOLDERS Chad Therapeutics, Inc. We have audited the accompanying balance sheets of Chad Therapeutics, Inc. as of March 31, 1998 and 1997 and the related statements of earnings, shareholders' equity and cash flows for the three years ended March 31, 1998. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Chad Therapeutics, Inc. as of March 31, 1998 and 1997 and the results of its operations and its cash flows for the three years ended March 31, 1998, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Los Angeles, California May 1, 1998, except as to Note 11 which is as of May 7, 1998 18 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Sales for the years ended March 31, 1998 and 1997, decreased $9,568,000 (36.6%) and increased $5,802,000 (28.5%), respectively, from the prior year's periods. There were no price changes during 1997 and 1996. While there have been limited price reductions in 1998, the decrease in sales relates primarily to decreases in domestic unit sales in 1998 of OXYMATIC conservers and OXYLITE complete portable oxygen systems which are being affected by the current marketing environment for home oxygen therapy discussed below. Sales to foreign distributors represented 10% of total sales for the years' ended March 31, 1998 and 1997. Currently, management expects a small increase in sales to foreign distributors during the upcoming fiscal year and quarter to quarter sales will fluctuate depending on the timing of shipments. In addition, all foreign sales are transacted in dollars, thus annual unit sales could be affected by foreign currency fluctuations. The current procedure for reimbursement by Medicare for home oxygen services provides a prospective flat fee monthly payment based solely on the patient's prescribed oxygen requirement. Under this system, inexpensive concentrators have grown in popularity because of low cost and less frequent servicing requirements. At the same time, interest heightened in oxygen conserving devices which can extend the life of oxygen supplies and reduce service calls by dealers. Management believes these reimbursement procedures have heightened interest in the cost savings and improved mobility afforded by oxygen conserving devices such as the Company's 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 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 24% and 31% of the Company's domestic sales for the years ended March 31, 1998 and 1997, respectively. Margins on these sales may be somewhat lower due to quantity pricing. In some instances this has resulted in reduced purchases as the former independent provider complies with the chain's purchasing policies. The Company's products, which allow homecare dealers to provide cost efficient home oxygen therapy, are ideally suited for use in a managed care environment and as a tool for dealers to increase revenues and profits. To ensure continued awareness of the benefits of the Company's products by chain headquarters personnel, a proactive marketing and communication program is in effect with all of the major national chains. The Company believes that its revenues at the end of fiscal 1997 and during the year ended March 31, 1998, were affected by several factors. During the year ended March 31, 1998, management believes sales to national chain accounts decreased as programs to convert patients to more acceptable ambulatory systems in the previous year did not recur. In addition, sales to national chain accounts as well as independent dealers have also been impacted by increased competitive factors and uncertainties regarding the size of potential cuts in Medicare home oxygen reimbursement which were being discussed as part of the Federal budget process. This process has now been finalized and a 25% cut in home oxygen reimbursement went into effect January, 1998. The effects of managed care and concerns over the severity of reimbursement cuts has, in many cases, resulted in the provision of systems to patients that do not provide truly ambulatory oxygen. Management believes these factors, including uncertainties as to how home care providers will respond to the 25% cut, may continue to adversely affect the Company's revenues from sales of oxygen conserving devices for the foreseeable future. Management also believes future revenues may be positively affected by sales of a new product, the TOTAL 0[subscript]2(TM) Delivery System. The TOTAL 0[subscript]2 system provides stationary oxygen for patients at home, portable oxygen including an oxygen conserving device for ambulation and a safe and efficient mechanism for filling portable oxygen cylinders. This should provide home care dealers with a means to deal with the reimbursement cuts discussed above by reducing their monthly cost of servicing patients while at the same time providing a higher quality of service by maximizing ambulatory capability. The Company received clearance in November 1997, to sell the new product from the Food and Drug Administration. The Company began shipping TOTAL 0[subscript]2 systems in January and realized approximately $535,000 in sales through March 31, 1998. The sales potential for the new system is significant as the average selling price is anticipated to be approximately four times that of the OXYMATIC and OXYLITE systems. No estimate can currently be made regarding the level of success the Company may achieve with the TOTAL 0[subscript]2 system. Cost of sales as a percent of net sales increased from 43.4% to 52.3% and from 41.7% to 43.4%, respectively, for the years ended March 31, 1998 and 1997, as compared to the prior year's periods. Both years have been affected by higher fixed overhead costs associated with the Company's move to new facilities in October, 1996. In addition, the year ended March 31, 1998, has been affected by decreased sales volume and start-up costs associated with the manufacture of the TOTAL 02 system. Management believes the gross margins should remain at or near current levels in future periods. 19 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Selling, general and administrative expenditures increased from $5,595,000 to $6,042,000 and from $4,791,000 to $5,595,000 for the years ended March 31, 1998 and 1997, respectively. These increases related to the Company's move to new facilities in October 1996, and the costs of preparing to bring the Company's new TOTAL 02 system product to market. The Company does not anticipate a decrease in these expenses in the coming years. Research and development expenses decreased by $197,000 for the year ended March 31, 1998, as compared to the prior year's period. Currently, management expects research and development costs to total approximately $800,000 in the fiscal year ended March 31, 1999, on projects to enhance and expand the Company's product line. FINANCIAL CONDITION At March 31, 1998, the Company had cash totaling $1,579,000 or 9% of total assets, as compared to $2,289,000 (14%) at March 31, 1997. Net working capital decreased from $10,985,000 at March 31, 1997, to $10,704,000 at March 31, 1998. Accounts receivable increased $140,000 during the year ended March 31, 1998. Future increases or decreases in accounts receivable will generally coincide with sales volume fluctuations and the timing of shipments to foreign customers. During the same period, inventories increased $1,070,000. This increase relates primarily to raw materials purchased for the manufacture of the new TOTAL 02 product line. The Company attempts to maintain sufficient inventories to meet its customer needs as orders are received. Thus, future inventory and related accounts payable levels will be impacted by the ability of the Company to maintain its safety stock levels. If safety stock levels drop below target amounts, then inventories in subsequent periods will increase more rapidly as inventory balances are replenished. Management believes funds derived from operations should be adequate to meet the Company's present cash requirements. However, should the Company achieve rapid market penetration with the new TOTAL 02 product line it may need additional funds on a short term basis. The Company has entered into an agreement with its bank to provide a line of credit for up to $2,000,000 if such funds are necessary for expansion of the TOTAL 02 product line. The Company expects capital expenditures during the next twelve months to be approximately $750,000. On June 30, 1994, the Company announced that the Board of Directors had authorized stock repurchases of its common shares in privately negotiated transactions for a minimum of 10,000 shares. While the Company made no stock repurchases during the year ended March 31, 1998, the Company may make additional stock repurchases pursuant to the Board of Directors authorization in the future. In addition, the Board has authorized the Company to purchase shares of the Company's common stock in open market transactions. During the year ended March 31, 1998, the Company purchased approximately 38,000 shares at a cost of $285,000, however, the number of shares which may be purchased under these programs in the future can not be predicted at this time. The Company does not provide post employment retirement benefits. YEAR 2000 Management has initiated an enterprise-wide program to prepare the Company's computer systems and applications for the year 2000. The Company expects to incur internal staff costs as well as consulting and other expenses related to infrastructure and facilities enhancements necessary to prepare the systems for the year 2000. The cost of testing and conversion of system applications is expected to be minimal. A significant proportion of these costs are not likely to be incremental costs to the Company, but rather will represent the redeployment of existing information technology resources. NEWLY ISSUED ACCOUNTING STANDARDS The Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income" ("FAS 130"), in June 1997. FAS 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. FAS 130 is effective for both interim and annual periods beginning after December 15, 1997. The Company will adopt FAS 130 in the first quarter of the fiscal year ending March 31, 1999. Management believes that the adoption of FAS 130 will not have a material impact on the Company's financial position or results of operations. The Financial Accounting Standards Board issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131"), in June 1997. FAS 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. It replaces the "industry segment" concept of FAS No. 14, "Financial Reporting for Segments of a Business Enterprise," with a "management approach" concept as to basis for identifying reportable segments. FAS 131 is effective for financial statements for periods beginning after December 15,1997. The Company will adopt FAS 131 in the annual financial statements of the fiscal year ending March 31, 1999. Management believes the adoption of FAS 131 will not have a material impact on the Company's financial position or results of operations. 20 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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. The Company's future growth in the near term will depend in significant part upon the commercial success of the TOTAL 02 Delivery System. The success of this new product will depend upon the health care community's perception of the system's capabilities, clinical efficacy and benefit to patients. In addition, prospective sales will be impacted by the degree of acceptance it achieves among home oxygen dealers and patients requiring supplementary oxygen. As with the introduction of any new product, the Company's ability to successfully promote the TOTAL 02 Delivery System cannot be assessed at this time. CONSOLIDATION OF HOME CARE INDUSTRY The home health care industry is undergoing significant consolidation. As a result, the market for the Company's products is increasingly influenced by major national chains. Three major national chains presently account for 24% of the Company's domestic sales. Future sales may be increasingly dependent on a limited number of customers which may have an impact on margins due to quantity pricing. COMPETITION Chad's success over the past several years has drawn new competition to vie for a share of the home oxygen market. These new competitors include both small and very large companies. While the Company believes the quality of its products and its established reputation will continue to be a competitive advantage, some competitors have successfully introduced lower price products which do not provide oxygen conserving capabilities comparable to the Company's products and no assurance can be given that increased competition in the home oxygen market will not continue to have an adverse effect 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. There are wide variations among these bills and proposals. Because of the uncertain state of the health care proposals, it is not meaningful at this time to predict the effect on the business of the Company if any of these proposals is enacted. Federal law has altered the payment rates available to providers of Medicare services in various ways during the last several years. Congress has passed legislation which would reduce Medicare spending. It cannot be predicted how changes in reimbursement levels will affect the home oxygen industry and there can be no assurance that such changes will not have an adverse effect on the Company's business. PATENTS AND TRADEMARKS The Company pursues a policy of obtaining patents for appropriate inventions related to products marketed or manufactured by the Company. The Company considers the patentability of its products to be significant to the success of the Company. To the extent that the products marketed by the Company do not receive patent protection, competitors may be able to manufacture and market substantially similar products. Such competition could have an adverse impact upon the Company's business. PRODUCTS LIABILITY The nature of the Company's business subjects it to potential legal actions asserting that the Company is liable for damages for product liability claims. Although the Company maintains products liability insurance in an amount which it believes to be customary in the industry, there is no assurance that this insurance will be sufficient to cover the costs of defense or judgments which might be entered against the Company. The type and frequency of these claims could have an 21 19 adverse impact on the Company's results of operations and financial position. AVAILABILITY OF THIRD PARTY COMPONENT PRODUCTS The Company tests and packages its products in its own facility. Some of its other manufacturing processes are conducted by other firms and the Company expects to continue using outside firms for certain manufacturing processes for the foreseeable future. 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 financial position. ADDITIONAL RISK FACTORS Additional factors which might affect the Company's performance may be listed from time to time in the reports filed by the Company with the Securities and Exchange Commission. 22 20 CORPORATE DATA OFFICERS CHARLES R. ADAMS Chairman THOMAS E. JONES Chief Executive Officer FRANCIS R. FLEMING President and Chief Operating Officer EARL L. YAGER Senior Vice President, Chief Financial Officer and Secretary OSCAR J. SANCHEZ Vice President, Development and Engineering LOUIE GORYOKA Vice President, Quality Assurance and Regulatory Affairs DIRECTORS CHARLES R. ADAMS Chairman Chad Therapeutics, Inc. THOMAS E. JONES Chief Executive Officer Chad Therapeutics, Inc. FRANCIS R. FLEMING President Chad Therapeutics, Inc. EARL L. YAGER Senior Vice President Chad Therapeutics, Inc. DAVID L. CUTTER Retired Chairman Of The Board Cutter Laboratories, Inc. NORMAN COOPER Retires Chairman Kallir, Philips, Ross, Inc. JOHN C. BOYD Retired PHILIP T. WOLFSTEIN President Wolfstein International, Inc. CORPORATE DATA CORPORATE HEADQUARTERS 21622 Plummer Street Chatsworth, CA 91311 (818) 882-0883 LEGAL COUNSEL Graham & James LLP AUDITORS KPMG Peat Marwick LLP Los Angeles, California TRANSFER AGENT AND REGISTRAR American Stock Transfer Company 40 Wall Street New York, NY 10005 COMMON STOCK PRICE RANGE The Company's Common Shares were traded on NASDAQ from its initial public offering on July 20, 1983 through February 10, 1987, under the NASDAQ symbol 3CTHU. From February 10, 1987 to August 3, 1993, the Company's Common Shares were not part of the automated quotations system. 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 range of high and low closing bid prices of the Company's Common Shares, as furnished by the National Quotation Bureau, Incorporated and high and low closing prices as furnished by the American Stock Exchange. Prices have been adjusted to reflect a 2 for l split distributed October 15, 1993, and a 3 for 2 split distributed on October 16, 1995.
QUARTER ENDED HIGH LOW - ---------------------------------------------------- June 30, 1996 19-1/8 12-1/2 September 30, 1996 19-7/8 15-1/4 December 31, 1996 20-5/8 14-1/8 March 31, 1997 16 10-5/8 June 30, 1997 12 5-3/4 September 30, 1997 12-3/16 7-5/8 December 31, 1997 12-5/16 8-7/8 March 31, 1998 9-5/16 6-1/4
Prices prior to August 3, 1993, represent quotations between dealers without adjustment for retail markups, markdown or commissions and may not represent actual transactions. As of June 12, 1998, there were approximately 311 shareholders of record of the Company's common stock. No cash dividends have been paid on the common stock. SEC FORM 10-K A copy of the Company's annual report to the Securities and Exchange Commission on Form 10-K is available without charge upon written request to: Senior Vice President Chad Therapeutics, Inc. 21622 Plummer Street Chatsworth, CA 91311 23 EX-23.1 4 EXHIBIT 23.1 1 EXHIBIT 23.1 ACCOUNTANT'S CONSENT The Board of Directors Chad Therapeutics, Inc.: We consent to incorporation by reference in the registration statement (No. 33-93734) on Form S-8 of Chad Therapeutics, Inc. of our report dated May 1, 1998, except for note 11 which is as of May 7, 1998, relating to the balance sheets of Chad Therapeutics, Inc. as of March 31, 1998 and 1997, and the related statements of earnings, shareholders' equity, and cash flows for each of the years in the three-year period ended March 31, 1998, which report appears in the March 31, 1998, annual report on Form 10-K of Chad Therapeutics, Inc. KPMG Peat Marwick LLP Los Angeles, California June 16, 1998 EX-28.7 5 EXHIBIT 28.7 1 [LOGO] EXHIBIT 28.7 [DEPARTMENT OF HEALTH & HUMAN SERVICES LETTERHEAD] Mr. Louie Goryoka Chad Therapeutics, Inc. 21622 Plummer Street Chatsworth, CA 91311 Re: K971889 Chad TOTAL 0[subscript]2 Delivery System Regulatory Class: II (two) Product Code: 73 CAW Dated: August 19, 1997 Received: August 20, 1997 Dear Mr. Goryoka: This letter corrects our substantially equivalent letter of November 17, 1997, regarding the error in the name of the contact person. We have reviewed your Section 510(k) notification of intent to market the device referenced above and we have determined the device is substantially equivalent (for the indications for use stated in the enclosure) to devices marketed in interstate commerce prior to May 28, 1976, the enactment date of the Medical Device Amendments or to devices that have been reclassified in accordance with the provisions of the Federal Food, Drug, and Cosmetic Act (Act). You may, therefore, market the device, subject to the general controls provisions of the Act. The general controls provisions of the Act include requirements for annual registration, listing of devices, good manufacturing practice, labeling, and prohibitions against misbranding and adulteration. If your device is classified (see above) into either class II (Special Controls) or class III (Premarket Approval) it may be subject to such additional controls. Existing major regulations affecting your device can be found in the Code of Federal Regulations, Title 21, Parts 800 to 895. A substantially equivalent determination assumes compliance with the Good Manufacturing Practice for Medical Devices: General (GMP) regulation (21 CFR Part 820) and that, through periodic GMP inspections, FDA will verify such assumptions. Failure to comply with the GMP regulation may result in regulatory action. In addition, the Food and Drug Administration (FDA) may publish further announcements 2 concerning your device in the Federal Register. Please note: this response to your premarket notification submission does not affect any obligation you might have under sections 531 through 542 of the Act for devices under the Electronic Product Radiation Control provisions, or other Federal laws or regulations. This letter will allow you to begin marketing your device as described in your 510(k) premarket notification. The FDA finding of substantial equivalence of your device to a legally marketed predicate device results in a classification for your device and thus, permits your device to proceed to the market. If you desire specific advice for your device on our labeling regulation (21 CFR Part 801 and additionally 809.10 for in vitro diagnostic devices), please contact the Office of Compliance at (301) 594-4648. Additionally, for questions on the promotion and advertising of your device, please contact the Office of Compliance at (301) 594-4639. Also, please note that the regulation entitled, "Misbranding by reference to premarket notification" (21 CFR 807.97). Other general information on your responsibilities under the Act may be obtained from the Division of Small Manufacturers Assistance at their toll free number (800) 638-2041 or at (301) 443-6597 or at its internet address "http://www.fda.gov/cdrh/dsmamain.html". Sincerely yours, /s/ Thomas J. Callahan Thomas J. Callahan, Ph.D. Director Division of Cardiovascular, Respiratory, and Neurological Devices Office of Device Evaluation Center for Devices and Radiological Health EX-27 6 EXHIBIT 27
5 1,000 YEAR MAR-31-1998 APR-01-1997 MAR-31-1998 1,579 0 2,469 0 7,133 12,066 5,275 1,310 17,436 1,362 0 13,100 0 0 2,974 17,436 16,593 0 8,670 6,755 0 0 0 1,332 535 0 0 0 0 797 .08 .08
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