##### 



Exhibit 13.1
 Selected Financial Data
 Selected Financial Data
 Years Ended March 31,2006
    
    2005
    
    2004
    
    2003
    
    2002Net sales
    
    $
    22,354,000
    
    
    $
    24,287,000
    
    
    $
    21,541,000
    
    
    $
    19,541,000
    
    
    $
    19,006,000Interest income, net
    
    
    20,000
    
    
    
    39,000
    
    
    
    22,000
    
    
    
    20,000
    
    
    
    50,000Net earnings (loss)
    
    
    (673,000
    )
    
    
    1,811,000
    
    
    
    1,001,000
    
    
    
    (433,000
    )
    
    
    1,157,000Basic earnings (loss) per share
    
    
    (.07
    )
    
    
    .18
    
    
    
    .10
    
    
    
    (.04
    )
    
    
    .12Diluted earnings (loss) per share
    
    
    (.07
    )
    
    
    .17
    
    
    
    .10
    
    
    
    (.04
    )
    
    
    .11Net working capital
    
    
    9,806,000
    
    
    
    10,393,000
    
    
    
    9,175,000
    
    
    
    8,224,000
    
    
    
    7,497,000Total assets
    
    
    14,356,000
    
    
    
    15,790,000
    
    
    
    13,043,000
    
    
    
    12,105,000
    
    
    
    12,323,000Shareholders equity
    
    
    12,395,000
    
    
    
    13,024,000
    
    
    
    11,153,000
    
    
    
    10,100,000
    
    
    
    10,373,000




---



##### 



Balance Sheets
 March 31,2006
    
    
    2005AssetsCurrent assets:Cash
    
    $
    935,000
    
    
    $
    177,000Accounts receivable, less allowance for doubtful
accounts of $52,000 and $39,000 in 2006 and 2005, respectively
    
    
    3,220,000
    
    
    
    3,745,000Income taxes refundable
    
    
    383,000
    
    
    
    Inventories (Note 2)
    
    
    6,381,000
    
    
    
    8,512,000Prepaid expenses and other assets
    
    
    178,000
    
    
    
    264,000Deferred income taxes (Note 3)
    
    
    666,000
    
    
    
    461,000Total current assets
    
    
    11,763,000
    
    
    
    13,159,000Property and equipment, at cost:Office equipment and furniture
    
    
    1,761,000
    
    
    
    1,854,000Machinery and equipment
    
    
    954,000
    
    
    
    957,000Tooling
    
    
    1,489,000
    
    
    
    1,441,000Leasehold improvements
    
    
    1,897,000
    
    
    
    1,888,0006,101,000
    
    
    
    6,140,000Less accumulated depreciation and amortization
    
    
    5,151,000
    
    
    
    4,949,000Net property and equipment
    
    
    950,000
    
    
    
    1,191,000Intangible assets, net (Note 4)
    
    
    972,000
    
    
    
    802,000Deferred income taxes (Note 3)
    
    
    600,000
    
    
    
    568,000Other assets
    
    
    71,000
    
    
    
    70,000$
    14,356,000
    
    
    $
    15,790,000Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    522,000
    
    
    $
    1,196,000Accrued expenses (Note 7)
    
    
    1,435,000
    
    
    
    1,370,000Income taxes payable (Note 3)
    
    
    
    
    
    
    200,000Total current liabilities
    
    
    1,957,000
    
    
    
    2,766,000Other liabilities
    
    
    4,000
    
    
    
    Commitments (Note 8)Shareholders equity (Note 5):Common shares, $0.01 par valueAuthorized 40,000,000 shares; 10,158,000
and 10,134,000 shares issued and outstanding
    
    
    13,413,000
    
    
    
    13,369,000Accumulated deficit
    
    
    (1,018,000
    )
    
    
    (345,000
    )Shareholders equity
    
    
    12,395,000
    
    
    
    13,024,000$
    14,356,000
    
    
    $
    15,790,000




---



##### 



Statement of Operations
 Years Ended March 31,2006
    
    
    2005
    
    
    2004Net sales
    
    $
    22,354,000
    
    
    $
    24,287,000
    
    
    $
    21,541,000Cost of sales
    
    
    15,113,000
    
    
    
    14,581,000
    
    
    
    12,846,000Gross profit
    
    
    7,241,000
    
    
    
    9,706,000
    
    
    
    8,695,000Costs and expenses:Selling, general and administrative
    
    
    6,788,000
    
    
    
    6,947,000
    
    
    
    6,436,000Research and development
    
    
    1,574,000
    
    
    
    1,473,000
    
    
    
    1,292,000Total costs and expenses
    
    
    8,362,000
    
    
    
    8,420,000
    
    
    
    7,728,000Operating income (loss)
    
    
    (1,121,000
    )
    
    
    1,286,000
    
    
    
    967,000Interest income, net
    
    
    20,000
    
    
    
    39,000
    
    
    
    22,000Other income (expense)
    
    
    (3,000
    )
    
    
    2,000
    
    
    
    12,000Earnings (loss) before income taxes
    
    
    (1,104,000
    )
    
    
    1,327,000
    
    
    
    1,001,000Income tax expense (benefit) (Note 3)
    
    
    (431,000
    )
    
    
    (484,000
    )
    
    
    Net earnings (loss)
    
    $
    (673,000
    )
    
    $
    1,811,000
    
    
    $
    1,001,000Basic earnings (loss) per share
    
    $
    (.07
    )
    
    $
    .18
    
    
    $
    .10Diluted earnings (loss) per share
    
    $
    (.07
    )
    
    $
    .17
    
    
    $
    .10Weighted shares outstanding:Basic
    
    
    10,146,000
    
    
    
    10,122,000
    
    
    
    10,084,000Diluted
    
    
    10,146,000
    
    
    
    10,625,000
    
    
    
    10,362,000




---



##### 



Statements of Shareholders Equity
 For the years ended March 31, 2006,
2005, and 2004
 Common Shares
    
    
    AccumulatedShares
    
    
    Amount
    
    
    DeficitBalance at March 31, 2003
    
    
    10,076,000
    
    
    $
    13,257,000
    
    
    $
    (3,157,000
    )Exercise of stock options
    
    
    20,000
    
    
    
    26,000
    
    
    
    Stock options granted as part of
technology acquisition
    
    
    
    
    
    
    23,000
    
    
    
    Tax benefit from exercise of
non-qualified stock options
    
    
    
    
    
    
    3,000
    
    
    
    Net earnings
    
    
    
    
    
    
    
    
    
    
    1,001,000Balance at March 31, 2004
    
    
    10,096,000
    
    
    
    13,309,000
    
    
    
    (2,156,000
    )Exercise of stock options
    
    
    38,000
    
    
    
    60,000
    
    
    
    Net earnings
    
    
    
    
    
    
    
    
    
    
    1,811,000Balance at March 31, 2005
    
    
    10,134,000
    
    
    
    13,369,000
    
    
    
    (345,000
    )Exercise of stock options
    
    
    24,000
    
    
    
    29,000
    
    
    
    Tax benefit from exercise of
non-qualified stock options
    
    
    
    
    
    
    15,000
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    (673,000
    )Balance at March 31, 2006
    
    
    10,158,000
    
    
    $
    13,413,000
    
    
    $
    (1,018,000
    )




---



##### 



Statements of Cash Flows
 Years Ended March 31,2006
    
    
    2005
    
    
    2004Cash flows from operating activities:Net earnings (loss)
    
    $
    (673,000
    )
    
    $
    1,811,000
    
    
    $
    1,001,000Adjustments to reconcile net earnings (loss)
to net cash provided by (used in) operating activities:Depreciation and amortization of property and equipment
    
    
    418,000
    
    
    
    378,000
    
    
    
    448,000Amortization of intangibles
    
    
    40,000
    
    
    
    39,000
    
    
    
    2,000Provision for losses on receivables
    
    
    13,000
    
    
    
    (31,000
    )
    
    
    (74,000
    )Loss on asset disposition
    
    
    12,000
    
    
    
    
    
    
    
    57,000Tax benefit attributable to stock options
    
    
    15,000
    
    
    
    
    
    
    
    3,000Decrease (increase) in deferred income taxes
    
    
    (237,000
    )
    
    
    (805,000
    )
    
    
    (224,000
    )Changes in assets and liabilities:Decrease (increase) in accounts receivable
    
    
    512,000
    
    
    
    (803,000
    )
    
    
    (320,000
    )Decrease (increase) in inventories
    
    
    2,131,000
    
    
    
    (3,523,000
    )
    
    
    522,000Decrease (increase) in income taxes refundable
    
    
    (383,000
    )
    
    
    
    
    
    
    4,000Decrease (increase) in prepaid expenses
    
    
    86,000
    
    
    
    (31,000
    )
    
    
    368,000Decrease (increase) in other assets
    
    
    (1,000
    )
    
    
    (39,000
    )
    
    
    47,000Increase (decrease) in accounts payable
    
    
    (681,000
    )
    
    
    694,000
    
    
    
    (239,000
    )Increase (decrease) in accrued expenses
    
    
    65,000
    
    
    
    185,000
    
    
    
    (78,000
    )Increase (decrease) in income taxes payable
    
    
    (200,000
    )
    
    
    (3,000
    )
    
    
    202,000Net cash provided by (used in) operating activities
    
    
    1,117,000
    
    
    
    (2,128,000
    )
    
    
    1,719,000Cash flows from investing activities:Additions to intangible assets
    
    
    (210,000
    )
    
    
    (112,000
    )
    
    
    (146,000
    )Capital expenditures
    
    
    (175,000
    )
    
    
    (351,000
    )
    
    
    (487,000
    )Net cash used in investing activities
    
    
    (385,000
    )
    
    
    (463,000
    )
    
    
    (633,000
    )Cash flows from financing activities:Exercise of stock options
    
    
    29,000
    
    
    
    60,000
    
    
    
    26,000Other liabilities
    
    
    (3,000
    )
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    26,000
    
    
    
    60,000
    
    
    
    26,000Net increase (decrease) in cash
    
    
    758,000
    
    
    
    (2,531,000
    )
    
    
    1,112,000Cash beginning of year
    
    
    177,000
    
    
    
    2,708,000
    
    
    
    1,596,000Cash end of year
    
    $
    935,000
    
    
    
    177,000
    
    
    $
    2,708,000Supplemental disclosure of cash flow information:Cash paid during the year for:Income taxes
    
    
    348,000
    
    
    
    325,000
    
    
    
    13,000Acquisition of capital assets through capital lease
    
    $
    14,000
    
    
    $
    
    
    
    $
    




---



##### 



Notes to Financial Statements
 (1) Summary of Significant Accounting Policies
 The Company
  Fair Value of Financial Instruments
  Inventories
  Property and Equipment
  Office Equipment and Furniture
    
    5-10 YearsMachinery and Equipment
    
    3-10 YearsTooling
    
    4 Years
  Use of Estimates
   Impairment of Long-Lived Assets
  Revenue Recognition
  Comprehensive Income (Loss)
  Royalty Expense
  Earnings (Loss) Per Common Share
  2006
    
    
    2005
    
    
    2004Basic earnings (loss) per shareNumerator  net earnings (loss)
    
    $
    (673,000
    )
    
    $
    1,811,000
    
    
    $
    1,001,000Denominator  weighted common
shares outstanding
    
    
    10,146,000
    
    
    
    10,122,000
    
    
    
    10,084,000Basic earnings (loss) per share
    
    $
    (.07
    )
    
    $
    .18
    
    
    $
    .10Diluted earnings (loss) per shareNumerator  net earnings (loss)
    
    $
    (673,000
    )
    
    $
    1,811,000
    
    
    $
    1,001,000Denominator  weighted common
shares outstanding
    
    
    10,146,000
    
    
    
    10,122,000
    
    
    
    10,084,000Diluted potential common shares
    
    
    
    
    
    
    503,000
    
    
    
    278,00010,146,000
    
    
    
    10,625,000
    
    
    
    10,362,000Diluted earnings (loss) per share
    
    $
    (.07
    )
    
    $
    .17
    
    
    $
    .10
  Income Taxes




---



##### 



Notes
to Financial Statements
  Major Customer
 2006
    
    2005
    
    2004Customer A**
    
    
    36.0
    %
    
    
    35.8
    %
    
    
    26.5
    %Customer B**
    
    
    *
    
    
    
    10.8
    %
    
    
    14.5
    %Customer C
    
    
    11.0
    %
    
    
    *
    
    
    
    *
 
 *
    
    Indicates sales less than 10%
of the Companys net sales.**
    
    Indicates national chain
customer.  Concentration of Credit Risk
   2006
    
    2005Customer A**
    
    
    25.4
    %
    
    
    26.0
    %Customer B
    
    
    21.6
    %
    
    
    *Customer C
    
    
    *
    
    
    
    22.6
    %
 
 *
    
    Indicates accounts receivable balance less
than 10% of gross accounts receivable.**
    
    Indicates national chain customer. Stock Option Plan
  Accounting for Stock-Based Compensation,
 Year Ended March 31,2006
    
    
    2005
    
    
    2004Net earnings (loss), as reported
    
    $
    (673,000
    )
    
    $
    1,811,000
    
    
    $
    1,001,000Deduct: Total stock-based
employee compensation expense
determined under fair-value-
based method for all awards,
net of related tax effects
    
    
    (128,000
    )
    
    
    (108,000
    )
    
    
    (81,000
    )Pro forma net earnings (loss)
    
    $
    (801,000
    )
    
    $
    1,703,000
    
    
    $
    920,000Earnings (loss) per share:Basic  as reported
    
    $
    (.07
    )
    
    $
    .18
    
    
    $
    .10Basic  pro forma
    
    
    (.08
    )
    
    
    .17
    
    
    
    .09Diluted  as reported
    
    
    (.07
    )
    
    
    .17
    
    
    
    .10Diluted  pro forma
    
    $
    (.08
    )
    
    $
    .16
    
    
    $
    .09
  2006
    
    2005
    
    2004Risk-free interest rate
    
    
    4.3
    %
    
    
    3.3
    %
    
    
    3.9
    %Forfeiture rate
    
    
    4.0
    %
    
    
    4.0
    %
    
    
    4.0
    %Dividend yield
    
    
    .0
    
    
    
    .0
    
    
    
    .0Volatility
    
    
    79.0
    %
    
    
    78.0
    %
    
    
    82.0
    %Expected life (years)
    
    
    8.0
    
    
    
    8.0
    
    
    
    8.0
 Segment Information
  Reclassifications
   (2) Inventories
  2006
    
    
    2005Finished goods
    
    $
    1,706,000
    
    
    $
    2,767,000Work in process
    
    
    1,234,000
    
    
    
    1,790,000Raw materials
and supplies
    
    
    3,441,000
    
    
    
    3,955,000$
    6,381,000
    
    
    $
    8,512,000




---



##### 



Notes
to Financial Statements
 (3) Income Taxes
  2006
    
    
    2005
    
    
    2004Current:Federal
    
    $
    (217,000
    )
    
    $
    307,000
    
    
    $
    204,000State
    
    
    7,000
    
    
    
    15,000
    
    
    
    16,000(210,000
    )
    
    
    322,000
    
    
    
    220,000Deferred:Federal
    
    
    (149,000
    )
    
    
    (466,000
    )
    
    
    (204,000
    )State
    
    
    (72,000
    )
    
    
    (340,000
    )
    
    
    (16,000
    )(221,000
    )
    
    
    (806,000
    )
    
    
    (220,000
    )Total
    
    $
    (431,000
    )
    
    $
    (484,000
    )
    
    $
    
  2006
    
    
    2005
    
    
    2004Statutory tax
expense (benefit)
    
    $
    (375,000
    )
    
    $
    451,000
    
    
    $
    341,000State income tax, net
    
    
    (51,000
    )
    
    
    72,000
    
    
    
    Valuation allowance
    
    
    9,000
    
    
    
    (1,004,000
    )
    
    
    (383,000
    )Warranty and other
    
    
    (14,000
    )
    
    
    (3,000
    )
    
    
    42,000$
    (431,000
    )
    
    $
    (484,000
    )
    
    $
    
  2006
    
    
    2005Bad debt reserves
    
    $
    21,000
    
    
    $
    15,000Accrued expenses
    
    
    263,000
    
    
    
    265,000Inventories
    
    
    344,000
    
    
    
    83,000Depreciation and amortization
    
    
    241,000
    
    
    
    237,000Intangible assets
    
    
    261,000
    
    
    
    325,000Net operating loss
    
    
    147,000
    
    
    
    99,000Other
    
    
    2,000
    
    
    
    5,000Total deferred tax assets
    
    
    1,279,000
    
    
    
    1,029,000Deferred tax liabilities:Valuation allowance
    
    
    (13,000
    )
    
    
    Net deferred tax assets
    
    $
    1,266,000
    
    
    $
    1,029,000
  (4) Intangible Assets
  (5) Shareholders Equity
  WeightedAverageOption
    
    
    PriceShares
    
    
    Per ShareIncentive options:Outstanding  March 31, 2003
    
    
    789,000
    
    
    $
    2.37Cancelled
    
    
    (16,000
    )
    
    
    3.44Granted
    
    
    15,000
    
    
    
    2.80Exercised
    
    
    (9,000
    )
    
    
    .78Outstanding  March 31, 2004
    
    
    779,000
    
    
    
    2.37Cancelled
    
    
    (13,000
    )
    
    
    2.51Exercised
    
    
    (17,000
    )
    
    
    1.02Expired
    
    
    (83,000
    )
    
    
    8.19Outstanding  March 31, 2005
    
    
    666,000
    
    
    
    1.98Cancelled
    
    
    (7,000
    )
    
    
    3.33Granted
    
    
    40,000
    
    
    
    3.41Exercised
    
    
    (24,000
    )
    
    
    1.16Outstanding  March 31, 2006
    
    
    675,000
    
    
    $
    2.10Exercisable  March 31, 2006
    
    
    635,000
    
    
    $
    2.03Non-qualified options:Outstanding  March 31, 2003
    
    
    300,000
    
    
    
    5.37Cancelled
    
    
    (42,000
    )
    
    
    8.20Granted
    
    
    75,000
    
    
    
    2.04Exercised
    
    
    (11,000
    )
    
    
    1.58Outstanding  March 31, 2004
    
    
    322,000
    
    
    
    4.30Cancelled
    
    
    (41,000
    )
    
    
    8.33Granted
    
    
    55,000
    
    
    
    3.71Exercised
    
    
    (21,000
    )
    
    
    2.07Expired
    
    
    (6,000
    )
    
    
    5.18Outstanding  March 31, 2005
    
    
    309,000
    
    
    
    3.83Expired
    
    
    (39,000
    )
    
    
    11.88Outstanding  March 31, 2006
    
    
    270,000
    
    
    $
    9.56Exercisable  March 31, 2006
    
    
    267,000
    
    
    $
    2.70




---



##### 



Notes
to Financial Statements
  Range of Exercise Prices$.50-6.69
    
    
    $7.62-12.54Number outstanding
    
    
    929,000
    
    
    
    16,000Weighted average
remaining life (yrs.)
    
    
    5.2
    
    
    
    1.5Weighted average
exercise price
    
    $
    2.10
    
    
    $
    9.56Number exercisable
    
    
    887,000
    
    
    
    15,000Weighted average
exercise price
    
    $
    2.10
    
    
    $
    9.56
  (6) Employee Benefit Plan
  (7) Accrued Expenses
  2006
    
    
    2005Accrued royalties
    
    $
    267,000
    
    
    $
    347,000Accrued vacation
    
    
    205,000
    
    
    
    182,000Warranty reserve
    
    
    139,000
    
    
    
    109,000Payroll and incentive
compensation
    
    
    86,000
    
    
    
    215,000Accrued inventory in transit
    
    
    175,000
    
    
    
    Customer deposits
    
    
    152,000
    
    
    
    132,000Accrued extended warranty
    
    
    95,000
    
    
    
    90,000Other
    
    
    316,000
    
    
    
    295,000$
    1,435,000
    
    
    $
    1,370,000
 (8) Commitments
       Operating
    
    Minimum
    
    
    
    
    
    CapitalLease
    
    Royalty
    
    Employee
    
    LeaseObligation
    
    Obligation
    
    Obligations
    
    Obligations2007
    
    $
    441,000
    
    
    $
    523,000
    
    
    $
    160,000
    
    
    $
    7,0002008
    
    
    454,000
    
    
    
    530,000
    
    
    
    160,000
    
    
    
    4,0002009
    
    
    113,000
    
    
    
    530,000
    
    
    
    160,000
    
    
    
    2010
    
    
    
    
    
    
    530,000
    
    
    
    
    
    
    
    2011
    
    
    
    
    
    
    530,000
    
    
    
    
    
    
    
    Thereafter
    
    $
    
    
    
    $
    427,000
    
    
    $
    
    
    
    $
    




---



##### 



Notes
to Financial Statements
 (9) Geographic Information
  2006
    
    
    2005
    
    
    2004United States
    
    $
    17,996,000
    
    
    $
    22,912,000
    
    
    $
    20,498,000Canada
    
    
    193,000
    
    
    
    306,000
    
    
    
    303,000Japan
    
    
    506,000
    
    
    
    405,000
    
    
    
    238,000Europe
    
    
    3,337,000
    
    
    
    418,000
    
    
    
    278,000All other countries
    
    
    322,000
    
    
    
    246,000
    
    
    
    224,000$
    22,354,000
    
    
    $
    24,287,000
    
    
    $
    21,541,000
  ®
 (10) Valuation and Qualifying Accounts and Reserves
  Balance at
    
    Charged to
    
    
    
    
    
    BalanceBeginning
    
    Costs and
    
    
    
    
    
    at Endof Year
    
    Expenses
    
    Deductions
    
    
    of YearAllowance for
doubtful accounts:2004
    
    $
    112,000
    
    
    7,000
    
    
    51,000
    
    
    $
    68,0002005
    
    
    68,000
    
    
    
    
    
    29,000
    
    
    
    39,0002006
    
    $
    39,000
    
    
    28,000
    
    
    15,000
    
    
    $
    52,000Warranty reserve:2004
    
    $
    140,000
    
    
    22,000
    
    
    59,000
    
    
    $
    103,0002005
    
    
    103,000
    
    
    57,000
    
    
    51,000
    
    
    
    109,0002006
    
    $
    109,000
    
    
    64,000
    
    
    34,000
    
    
    $
    139,000
 (11) Quarterly Financial Data (Unaudited)
  DilutedEarningsGross
    
    
    Net
    
    
    (Loss)Revenue
    
    
    Profit
    
    
    Earnings
    
    
    Per Share2006First quarter
    
    $
    5,895,000
    
    
    $
    2,101,000
    
    
    $
    (42,000
    )
    
    $
    .00Second quarter
    
    
    5,375,000
    
    
    
    1,781,000
    
    
    
    (210,000
    )
    
    
    (.02
    )Third quarter
    
    
    5,907,000
    
    
    
    2,101,000
    
    
    
    39,000
    
    
    
    .00Fourth quarter
    
    
    5,177,000
    
    
    
    1,258,000
    
    
    
    (460,000
    )
    
    
    (.05
    )Year
    
    $
    22,354,000
    
    
    $
    7,241,000
    
    
    $
    (673,000
    )
    
    $
    (.07
    )2005First quarter
    
    $
    6,099,000
    
    
    $
    2,420,000
    
    
    $
    262,000
    
    
    $
    0.02Second quarter
    
    
    6,309,000
    
    
    
    2,613,000
    
    
    
    455,000
    
    
    
    0.04Third quarter
    
    
    6,444,000
    
    
    
    2,703,000
    
    
    
    505,000
    
    
    
    0.05Fourth quarter
    
    
    5,435,000
    
    
    
    1,970,000
    
    
    
    589,000
    
    
    
    0.06Year
    
    $
    24,287,000
    
    
    $
    9,706,000
    
    
    $
    1,811,000
    
    
    $
    0.17
 (12) Accounting Standards




---



##### 



Report ofIndependentRegisteredPublicAccountingFirm
 The Board of
Directors
and Shareholders  CHAD Therapeutics, Inc.
    
 11




---



##### 



Managements Discussion and Analysis of Financial
Condition and Results of Operation
 Overview
    ® ® ®
  2 ® 2 2
  
    
    Development of additional oxygen conserver
models, such as the LOTUS Electronic Oxygen
conserver introduced in October 2004, that
diversify the product line in order to offer
customers a wide range of oxygen conservation
choices;
 12




---



##### 



Managements Discussion and Analysis of Financial
Condition and Results of Operation
 
    
    A continued promotional and educational
campaign with respect to the benefits of the
TOTAL O2 system; and
 
    
    An effort to expand the Companys product lines
and improve existing products through the
investment in and development of new
technologies, such as proprietary sensor
technology and control software licensed in
January of 2003 and the introduction of the SAGE
Oxygen Therapeutic Device in May 2004. These new
technologies will provide the Company with an
opportunity to expand its oxygen delivery product
lines and potentially enter the high-growth sleep
disorder market.
  Results of Operations
   2
   Financial Condition
  13




---



##### 



Managements Discussion and Analysis of Financial
Condition and Results of Operation
     Payments Due By PeriodContractual
    
    
    
    
    
    Less than 1
    
    1-3
    
    3-5
    
    After 5Cash Obligations
    
    Total
    
    Year
    
    Years
    
    Years
    
    YearsOperating lease obligations
    
    $
    1,008,000
    
    
    $
    441,000
    
    
    $
    567,000
    
    
    
    
    
    
    
    Minimum royalty obligations
    
    $
    3,070,000
    
    
    $
    523,000
    
    
    $
    1,590,000
    
    
    $
    882,000
    
    
    $
    75,000Employee obligations
    
    $
    480,000
    
    
    $
    160,000
    
    
    $
    320,000
    
    
    
    
    
    
    
    Capital lease obligations
    
    $
    11,000
    
    
    $
    7,000
    
    
    $
    4,000
    
    
    
    
    
    
    
    
    Significant Accounting Policies
     14




---



##### 



Managements Discussion and Analysis of Financial
Condition and Results of Operation
   Outlook: Issues & Risks
  Dependence Upon a Single Product Line
  New Products
 2
 Consolidation of Home Care Industry  Dependence on Key Customers
  Competition
  Rapid Technological Change
  Potential Changes in Administration of Health Care
   15




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##### 



Managements Discussion and Analysis of Financial
Condition and Results of Operation
 Protection of Intellectual Property Rights
  Product Liability
  Availability and Reliability of Third Party Component Products
  Accounting Standards
   Additional Risk Factors
  16




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##### 



CORPORATE DATA
 Common Stock Price Range
  Quarter Ended
    
    High
    
    LowJune 30, 2004
    
    
    4.39
    
    
    
    4.12September 30, 2004
    
    
    4.40
    
    
    
    4.26December 31, 2004
    
    
    5.50
    
    
    
    5.35March 31, 2005
    
    
    3.70
    
    
    
    3.10June 30, 2005
    
    
    3.87
    
    
    
    3.62September 30, 2005
    
    
    3.81
    
    
    
    3.71December 31, 2005
    
    
    3.60
    
    
    
    3.36March 31, 2006
    
    
    2.90
    
    
    
    2.50
  SEC Form 10-K
  
 Officers
 THOMAS E. JONES
 EARL L. YAGER
 ALFONSO DEL TORO
 TRACY A. KERN
 ERIKA LASKEY
 KEVIN McCULLOH
 PAULA OCONNOR
 SAMUEL PATTON
 OSCAR J. SANCHEZ
 Directors  THOMAS E. JONES
 EARL L. YAGER
 JOHN C. BOYD
 JAMES M. BROPHY
 KATHLEEN M. GRIGGS
 PHILIP T. WOLFSTEIN
 Corporate Data  CORPORATE HEADQUARTERS
 LEGAL COUNSEL
 AUDITORS
 TRANSFER AGENT AND REGISTRAR