##### Table of Contents



FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934

For Quarter Ended: September 30, 2003

Commission file number: 1-12214

CHAD THERAPEUTICS, INC.




(Exact name of registrant as specified in its charter)


|                                                                          |  |                                                
|------------------------------------------------------------------------- |  | -----------------------------------------------
|California
(State of other jurisdiction of
incorporation or organization) |  | 95-3792700
(I.R.S. Employer
Identification No.)

21622 Plummer Street, Chatsworth, CA 91311




(Address of principal executive offices) (Zip Code)


(818) 882-0883




(Registrants telephone number, including area code)




---

(Former Address)


(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months ( or for such shorter period that the
registrant was required to file such reports ), and (2) has been subject to
such filing requirements for the past 90 days. Yes  [X]   No   [  ]

APPLICABLE ONLY TO CORPORATE ISSURES:

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date:

|              |  |  |            | 
|------------- |  |  | ---------- | 
|Common Shares |  |  | 10,078,000 | 





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TABLE OF CONTENTS



|                                   |                                          |  |  |  |  |  |  | 
|---------------------------------- | ---------------------------------------- |  |  |  |  |  |  | 
|Condensed Balance Sheets          
|Condensed Statements of Operations
|                                   | Item 4. Controls and Procedures         
|Part II                           
|                                   | Item 6. Exhibits and Reports on Form 8-K
|SIGNATURES                        
|EXHIBIT 31.1                      
|EXHIBIT 31.2                      
|EXHIBIT 32                        



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CHAD THERAPEUTICS, INC.
Condensed Balance Sheets
September 30, 2003 and March 31, 2003
(Unaudited)

|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |            | 
|------------------------------------ | -------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | --------- | ------------- | ---------- | --------- | --------- | ---------- | ---------- | 
|                                     |                                                                                                                            |                                            |           | September 30, |            | March 31,
|                                     |                                                                                                                            |                                            |           | 2003          |            | 2003     
|                                     |                                                                                                                            |                                            |           |               |            |          
|ASSETS                               |                                                                                                                            |                                            |           |               |            |           |           |           
|Current Assets:                      |                                                                                                                            |                                            |           |               |            |           |           |           
|                                     | Cash                                                                                                                       |                                            | $         | 1,083,000     |            |           | $         | 1,596,000  |           
|                                     | Accounts receivable, less allowance for
doubtful accounts of $122,000 at
September 30, 2003 and $112,000 at
March 31, 2003 |                                            |           | 2,760,000     |            |           |           | 2,517,000  |           
|                                     | Income taxes refundable                                                                                                    |                                            |           | 4,000         |            |           |           | 4,000      |           
|                                     | Inventories (Note 2)                                                                                                       |                                            |           | 5,994,000     |            |           |           | 5,511,000  |           
|                                     | Prepaid Expenses                                                                                                           |                                            |           | 428,000       |            |           |           | 601,000    |           
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           
|                                     |                                                                                                                            | Total current assets                       |           |               | 10,269,000 |           |           |            | 10,229,000 | 
|Property and equipment, at cost      |                                                                                                                            |                                            | 6,386,000 |               |            |           | 6,215,000 |           
|                                     | Less accumulated depreciation                                                                                              |                                            |           | 5,233,000     |            |           |           | 4,979,000  |           
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           
|                                     |                                                                                                                            | Net property and equipment                 |           |               | 1,153,000  |           |           |            | 1,236,000  | 
|Other assets, net                    |                                                                                                                            |                                            | 643,000   |               |            |           | 640,000   |           
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           
|                                     |                                                                                                                            | Total assets                               |           | $             | 12,065,000 |           |           | $          | 12,105,000 | 
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           
|LIABILITIES AND SHAREHOLDERS EQUITY |                                                                                                                            |                                            |           |               |            |           |           |           
|Current liabilities:                 |                                                                                                                            |                                            |           |               |            |           |           |           
|                                     | Accounts payable                                                                                                           |                                            | $         | 597,000       |            |           | $         | 741,000    |           
|                                     | Accrued expenses                                                                                                           |                                            |           | 976,000       |            |           |           | 1,263,000  |           
|                                     | Income taxes payable                                                                                                       |                                            |           | 16,000        |            |           |           | 1,000      |           
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           
|                                     |                                                                                                                            | Total current liabilities                  |           |               | 1,589,000  |           |           |            | 2,005,000  | 
|Shareholders equity:                |                                                                                                                            |                                            |           |               |            |           |           |           
|                                     | Common shares, $.01 par value, authorized
40,000,000 shares; 10,078,000 and 10,076,000
shares issued and outstanding       |                                            |           | 13,259,000    |            |           |           | 13,257,000 |           
|                                     | Accumulated deficit                                                                                                        |                                            |           | (2,783,000    | )          |           |           | (3,157,000 | )         
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           
|                                     |                                                                                                                            | Total shareholders equity                 |           |               | 10,476,000 |           |           |            | 10,100,000 | 
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           
|                                     |                                                                                                                            | Total liabilities and shareholders equity |           | $             | 12,065,000 |           |           | $          | 12,105,000 | 
|                                     |                                                                                                                            |                                            |           |               |            |           |           |            |           

See accompanying notes to condensed financial statements.





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CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the three months ended September 30, 2003 and 2002
(Unaudited)

|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |           |           |            | 
|------------------- | ----------------------------------- | ---------------------------- | --------- | --------- | ------------- | ---------- | ------------------ |  |  | - | --------- | --------- | --------- | ---------- | 
|                    |                                     |                              |           |           |               |            | Three Months Ended |  | 
|                    |                                     |                              |           |           | September 30,
|                    |                                     |                              |           |           |              
|                    |                                     |                              |           |           | 2003          |            |                    |  |  |   | 2002     
|                    |                                     |                              |           |           |               |            |                    |  |  |   |          
|Net Sales           |                                     | $                            | 5,284,000 |           |               |            |                    |  |  | $ | 4,840,000 |          
|Cost of Sales       |                                     |                              | 2,918,000 |           |               |            |                    |  |  |   | 2,797,000 |          
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Gross profit                 |           |           | 2,366,000     |            |                    |  |  |   |           |           | 2,043,000 |           
|Costs and expenses: |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    | Selling, general and
administrative |                              |           | 1,868,000 |               |            |                    |  |  |   |           | 1,808,000 |          
|                    | Research and development            |                              |           | 345,000   |               |            |                    |  |  |   |           | 225,000   |          
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Total costs and expenses     |           |           | 2,213,000     |            |                    |  |  |   |           |           | 2,033,000 |           
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Operating income             |           |           | 153,000       |            |                    |  |  |   |           |           | 10,000    |           
|                    | Other Income  interest
income, net |                              |           | 4,000     |               |            |                    |  |  |   |           | 5,000     |          
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Earnings before income
taxes |           |           | 157,000       |            |                    |  |  |   |           |           | 15,000    |           
|Income tax expense  |                                     |                              | 7,000     |           |               |            |                    |  |  |   | 13,000    |          
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Net earnings                 |           | $         | 150,000       |            |                    |  |  |   |           | $         | 2,000     |           
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Basic earnings per share     |           | $         | 0.02          |            |                    |  |  |   |           | $         |          |           
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Diluted earnings per share   |           | $         | 0.02          |            |                    |  |  |   |           | $         |          |           
|                    |                                     |                              |           |           |               |            |                    |  |  |   |           |          
|                    |                                     | Weighted shares
outstanding: |           |           |               |            |                    |  |  |   |           |           |           |           
|                    |                                     |                              | Basic     |           |               | 10,076,000 |                    |  |  |   |           |           |           | 10,068,000 | 
|                    |                                     |                              | Diluted   |           |               | 10,313,000 |                    |  |  |   |           |           |           | 10,406,000 | 

See accompanying notes to condensed financial statements.





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CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the six months ended September 30, 2003 and 2002
(Unaudited)

|                    |                                     |                              |            |           |                  |            |           |           |           |            | 
|------------------- | ----------------------------------- | ---------------------------- | ---------- | --------- | ---------------- | ---------- | --------- | --------- | --------- | ---------- | 
|                    |                                     |                              |            |           | Six Months Ended
|                    |                                     |                              |            |           | September 30,   
|                    |                                     |                              |            |           |                 
|                    |                                     |                              |            |           | 2003             |            | 2002     
|                    |                                     |                              |            |           |                  |            |          
|Net Sales           |                                     | $                            | 10,953,000 |           |                  | $          | 9,862,000 |          
|Cost of Sales       |                                     |                              | 6,069,000  |           |                  |            | 5,679,000 |          
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Gross profit                 |            |           | 4,884,000        |            |           |           | 4,183,000 |           
|Costs and expenses: |                                     |                              |            |           |                  |            |           |          
|                    | Selling, general and administrative |                              |            | 3,833,000 |                  |            |           | 3,508,000 |          
|                    | Research and development            |                              |            | 668,000   |                  |            |           | 488,000   |          
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Total costs and expenses     |            |           | 4,501,000        |            |           |           | 3,996,000 |           
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Operating income             |            |           | 383,000          |            |           |           | 187,000   |           
|                    | Other Income  interest income, net |                              |            | 9,000     |                  |            |           | 9,000     |          
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Earnings before income taxes |            |           | 392,000          |            |           |           | 196,000   |           
|Income tax expense  |                                     |                              | 18,000     |           |                  |            | 16,000    |          
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Net earnings                 |            | $         | 374,000          |            |           | $         | 180,000   |           
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Basic earnings per share     |            | $         | 0.04             |            |           | $         | 0.02      |           
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Diluted earnings per share   |            | $         | 0.04             |            |           | $         | 0.02      |           
|                    |                                     |                              |            |           |                  |            |           |          
|                    |                                     | Weighted shares outstanding: |            |           |                  |            |           |           |           |           
|                    |                                     |                              | Basic      |           |                  | 10,076,000 |           |           |           | 10,068,000 | 
|                    |                                     |                              | Diluted    |           |                  | 10,297,000 |           |           |           | 10,417,000 | 

See accompanying notes to the condensed financial statements.





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CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the six months ended September 30, 2003
(Unaudited)

|                              |  |               |            |        |  |         |            |             |  |   |            |  
|----------------------------- |  | ------------- | ---------- | ------ |  | ------- | ---------- | ----------- |  | - | ---------- | -
|                              |  | Common Shares |            |        |  |         |            | Accumulated
|                              |  | Shares        |            | Amount |  | Deficit
|                              |  |               |            |        |  |        
|Balance as of March 31, 2003  |  |               | 10,076,000 |        |  | $       | 13,257,000 |             |  | $ | (3,157,000 | )
|Exercise of stock options     |  |               | 2,000      |        |  |         | 2,000      |             |  |   |           |  
|Net Earnings                  |  |               |           |        |  |         |           |             |  |   | 374,000    |  
|                              |  |               |            |        |  |         |            |             |  |   |            |  
|Balance at September 30, 2003 |  |               | 10,078,000 |        |  | $       | 13,259,000 |             |  | $ | (2,783,000 | )
|                              |  |               |            |        |  |         |            |             |  |   |            |  

See accompanying notes to consolidated financial statements.





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CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the six months ended September 30, 2003 and 2002
(Unaudited)

|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |          |         |          |           |  
|------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------------------- | ------------------------------------------- | --------------------------------------------------- | ------- | ---------------- | --------- | -------- | ------- | -------- | --------- | -
|                                      |                                                                                               |                                                         |                                             |                                                     |         | Six Months Ended
|                                      |                                                                                               |                                                         |                                             |                                                     |         | September 30,   
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                 
|                                      |                                                                                               |                                                         |                                             |                                                     |         | 2003             |           | 2002    
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |         
|Cash flows from operating activities: |                                                                                               |                                                         |                                             |                                                     |         |                  |           |         
|                                      | Net earnings                                                                                  |                                                         | $                                           | 374,000                                             |         |                  | $         | 180,000  |        
|                                      | Adjustments to reconcile net earnings to net cash
provided by (used in operating activities): |                                                         |                                             |                                                     |         |                  |           |          |        
|                                      |                                                                                               | Depreciation and amortization of property and
equipment |                                             |                                                     | 254,000 |                  |           |          | 338,000 |         
|                                      |                                                                                               | Amortization of intangibles                             |                                             |                                                     |        |                  |           |          | 55,000  |         
|                                      |                                                                                               | Changes in assets and liabilities:                      |                                             |                                                     |         |                  |           |          |         |         
|                                      |                                                                                               |                                                         | Decrease (increase) in accounts receivable  |                                                     |         | (243,000         | )         |          |         | (332,000 | )        
|                                      |                                                                                               |                                                         | Decrease (increase) in inventories          |                                                     |         | (483,000         | )         |          |         | (37,000  | )        
|                                      |                                                                                               |                                                         | Decrease (increase) income taxes refundable |                                                     |         |                 |           |          |         | 995,000  |          
|                                      |                                                                                               |                                                         | Decrease (increase) in prepaid expenses     |                                                     |         | 173,000          |           |          |         | (43,000  | )        
|                                      |                                                                                               |                                                         | Decrease (increase) in other assets         |                                                     |         | (3,000           | )         |          |         | 13,000   |          
|                                      |                                                                                               |                                                         | Increase (decrease) in accounts payable     |                                                     |         | (144,000         | )         |          |         | (91,000  | )        
|                                      |                                                                                               |                                                         | Increase (decrease) in accrued expenses     |                                                     |         | (287,000         | )         |          |         | (61,000  | )        
|                                      |                                                                                               |                                                         | Increase (decrease) in income taxes payable |                                                     |         | 15,000           |           |          |         | 5,000    |          
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |          |        
|                                      |                                                                                               |                                                         |                                             | Net cash provided by (used in)
operating activities |         |                  | (344,000  | )        |         |          | 1,022,000 |  
|Cash flows from investing activities: |                                                                                               |                                                         |                                             |                                                     |         |                  |           |         
|                                      | Capital expenditures                                                                          |                                                         |                                             | (171,000                                            | )       |                  |           | (147,000 | )      
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |          |        
|                                      |                                                                                               |                                                         |                                             | Net cash used in investing activities               |         |                  | (171,000  | )        |         |          | (147,000  | )
|Cash flows from financing activities: |                                                                                               |                                                         |                                             |                                                     |         |                  |           |         
|                                      | Exercise of stock options                                                                     |                                                         |                                             | 2,000                                               |         |                  |           | 9,000    |        
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |          |        
|                                      |                                                                                               |                                                         |                                             | Net cash provided by financing activities           |         |                  | 2,000     |          |         |          | 9,000     |  
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |          |        
|Net increase (decrease) in cash       |                                                                                               |                                                         | (513,000                                    | )                                                   |         |                  | 884,000   |         
|Cash beginning of period              |                                                                                               |                                                         | 1,596,000                                   |                                                     |         |                  | 520,000   |         
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |          |        
|Cash end of period                    |                                                                                               | $                                                       | 1,083,000                                   |                                                     |         | $                | 1,404,000 |         
|                                      |                                                                                               |                                                         |                                             |                                                     |         |                  |           |          |        

See accompanying notes to condensed financial statements.





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CHAND THERAPEUTICS, INC.
September 30, 2003
(Unaudited)



|1. |  | Interim Reporting                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  
|   |  | In the opinion of management, all adjustments necessary, which are of a
normal and recurring nature, for a fair presentation of the results for the
interim periods presented have been made. The results for the three and six
month periods ended September 30, 2003, are not necessarily indicative of the
results expected for the year ended March 31, 2004. The interim statements
are condensed and do not include some of the information necessary for a more
complete understanding of the financial data. Accordingly, your attention is
directed to the footnote disclosures found in the March 31, 2003, Annual
Report and particularly to Note 1 which includes a summary of significant
accounting policies.
|  
|2. |  | Inventories                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|  
|   |  | Inventories in 2003 are summarized as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

|                |  |              |           |          |  |   |           | 
|--------------- |  | ------------ | --------- | -------- |  | - | --------- | 
|                |  | September 30 |           | March 31
|                |  |              |           |         
|Finished goods  |  | $            | 1,124,000 |          |  | $ | 1,245,000 | 
|Work-in-process |  |              | 1,542,000 |          |  |   | 1,382,000 | 
|Raw materials   |  |              | 3,328,000 |          |  |   | 2,884,000 | 
|                |  |              |           |          |  |   |           | 
|                |  | $            | 5,994,000 |          |  | $ | 5,511,000 | 
|                |  |              |           |          |  |   |           | 





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##### Table of Contents



CHAND THERAPEUTICS, INC.
September 30, 2003
(Unaudited)



|3. |  | Earnings Per Common Share                                                                                                                
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Following is a reconciliation of the numerators and denominators used in the
calculation of basic and diluted earnings per common shares:

|                            |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |            |            | 
|--------------------------- | ------------------------------------------------------ | ------------------------------------------ | ---------- | ------------------ | ---------- | ---------------- | ---------- | ---------- | ---------- | ---- | ---------- | ---------- | ---------- |  | ---------- | ---------- | ---------- | 
|                            |                                                        |                                            |            | Three Months Ended |            | Six Months Ended
|                            |                                                        |                                            |            | 2003               |            | 2002             |            | 2003       |            | 2002
|                            |                                                        |                                            |            |                    |            |                  |            |            |            |     
|Basic earnings per share:   |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |           
|                            | Numerator-net earnings                                 |                                            | $          | 150,000            |            |                  | $          | 2,000      |            |      | $          | 374,000    |            |  | $          | 180,000    |           
|                            | Denominator-weighted average
common shares outstanding |                                            |            | 10,076,000         |            |                  |            | 10,068,000 |            |      |            | 10,076,000 |            |  |            | 10,068,000 |           
|                            |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |            |           
|Basic earnings per share    |                                                        |                                            | 0.02       |                    |            |                  | .00        |            |            |      | 0.04       |            |            |  | 0.02       |           
|                            |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |            |           
|Diluted earnings per share: |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |           
|                            | Numerator-net earnings                                 |                                            | $          | 150,000            |            |                  | $          | 2,000      |            |      | $          | 374,000    |            |  | $          | 180,000    |           
|                            | Denominator:                                           |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |            |           
|                            |                                                        | Weighted average common shares
outstanding |            |                    | 10,076,000 |                  |            |            | 10,068,000 |      |            |            | 10,076,000 |  |            |            | 10,068,000 | 
|                            |                                                        | Diluted effect of common stock options     |            |                    | 237,000    |                  |            |            | 338,000    |      |            |            | 221,000    |  |            |            | 349,000    | 
|                            |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |            |           
|                            |                                                        |                                            | 10,313,000 |                    |            |                  | 10,406,000 |            |            |      | 10,297,000 |            |            |  | 10,417,000 |           
|                            |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |            |           
|Diluted earnings per share  |                                                        |                                            | 0.02       |                    |            |                  | .00        |            |            |      | 0.04       |            |            |  | 0.02       |           
|                            |                                                        |                                            |            |                    |            |                  |            |            |            |      |            |            |            |  |            |            |           



|   |  | Options to purchase 572,000 shares of common stock at prices ranging from
$2.03 to $13.47 per share and 458,000 shares of common stock at prices
ranging from $3.35 to $13.47 were not included in the computation of diluted
earnings per share for the three and six month periods ended September 30,
2003 and 2002, respectively, because their effect would have been
anti-dilutive.                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|4. |  | Income Tax Expense                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  
|   |  | Income tax expense for the three and six month periods ended September 30,
2003, relate primarily to state income taxes which are provided for at an
effective rate of 4.5%. The Company has California net operating loss
carryforwards of $2,785,000, against which a full valuation allowance has
been recorded. In September, 2002, the state of California enacted
legislation that suspends the utilization of net operating loss carryforwards
during tax years starting 2002, effective retroactively back to January 1,
2002. As a result, the company will be unable to use its California net
operating loss carryforwards until the tax year beginning April 1, 2004. The
company also has manufacturing tax credit carryforwards of $46,000 available
to offset future California taxable income.





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##### Table of Contents



CHAND THERAPEUTICS, INC.
September 30, 2003
(Unaudited)



|5. |  | Geographic Information                                                                                               
|-- |  | ---------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Company has one reportable operating segment. Geographic information
regarding the Companys sales is as follows:

|                    |  |                    |           |                  |  |      |           |      |  |   |            |  |  |   |           | 
|------------------- |  | ------------------ | --------- | ---------------- |  | ---- | --------- | ---- |  | - | ---------- |  |  | - | --------- | 
|                    |  | Three Months Ended |           | Six Months Ended
|                    |  | September 30,      |           | September 30,   
|                    |  | 2003               |           | 2002             |  | 2003 |           | 2002
|                    |  |                    |           |                  |  |      |           |     
|United States       |  | $                  | 5,078,000 |                  |  | $    | 4,606,000 |      |  | $ | 10,494,000 |  |  | $ | 9,361,000 | 
|Canada              |  |                    | 51,000    |                  |  |      | 68,000    |      |  |   | 146,000    |  |  |   | 105,000   | 
|Germany             |  |                    | 4,000     |                  |  |      | 5,000     |      |  |   | 45,000     |  |  |   | 18,000    | 
|Japan               |  |                    | 17,000    |                  |  |      | 66,000    |      |  |   | 55,000     |  |  |   | 117,000   | 
|All other countries |  |                    | 134,000   |                  |  |      | 95,000    |      |  |   | 213,000    |  |  |   | 225,000   | 
|                    |  |                    |           |                  |  |      |           |      |  |   |            |  |  |   |           | 
|                    |  | $                  | 5,284,000 |                  |  | $    | 4,840,000 |      |  | $ | 10,953,000 |  |  | $ | 9,826,000 | 
|                    |  |                    |           |                  |  |      |           |      |  |   |            |  |  |   |           | 



|   |  | All long-lived assets are located in the United States.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Sales of
OXYMATIC     ® and CYPRESS OXYPneumatic® conservers systems accounted
for 77% and 73% of the Companys sales for the six month periods ended
September 30, 2003 and 2002, respectively.                                                                                                                                                                                                                                                                                                                                                              
|  
|6. |  | Stock Option Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|   |  | The company accounts for its stock option plan in accordance with the
provisions of Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The Company has
also adopted the pro forma disclosure provisions of Statement of Financial
Accounting Standards (SFAS) No. 123,Accounting for Stock-Based Compensation,
which permits entities to provide pro forma net income and pro forma net
earnings per share disclosures as if the fair-value-based method defined in
SFAS 123 had been applied.





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##### Table of Contents



CHAND THERAPEUTICS, INC.
September 30, 2003
(Unaudited)



| |  | The Company applies Accounting Principles Board Opinion No. 25 in accounting
for the Plan and no compensation expense has been recognized for its stock
options in the accompanying financial statements. The following table
illustrates the effect on net earnings (loss) and earnings (loss) per share
if the Company had applied the fair value recognition provision of FASB
Statement No. 123, Accounting for Stock Based Compensation, to stock-based
employee compensation:
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                                                                                            |  |                    |         |                  |  |      |         |      |  |  |         |   |  |  |         |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ---------------- |  | ---- | ------- | ---- |  |  | ------- | - |  |  | ------- | -
|                                                                                                                                            |  | Three Months Ended |         | Six Months Ended
|                                                                                                                                            |  | September 30,      |         | September 30,   
|                                                                                                                                            |  | 2003               |         | 2002             |  | 2003 |         | 2002
|                                                                                                                                            |  |                    |         |                  |  |      |         |     
|Net earnings, as reported                                                                                                                   |  |                    | 150,000 |                  |  |      | 2,000   |      |  |  | 374,000 |   |  |  | 180,000 |  
|Deduct: Total stock based employee
compensation expense determined under
fair value-based method for all awards, net
of related tax effects |  |                    | (30,000 | )                |  |      | (39,000 | )    |  |  | (59,000 | ) |  |  | (74,000 | )
|                                                                                                                                            |  |                    |         |                  |  |      |         |      |  |  |         |   |  |  |         |  
|Pro forma net income (loss)                                                                                                                 |  |                    | 120,000 |                  |  |      | (37,000 | )    |  |  | 315,000 |   |  |  | 106,000 |  
|Earnings per share:                                                                                                                         |  |                    |         |                  |  |      |         |      |  |  |         |   |  |  |         |  
|Basic  as reported                                                                                                                         |  |                    | 0.01    |                  |  |      |        |      |  |  | 0.04    |   |  |  | 0.02    |  
|Basic  pro forma                                                                                                                           |  |                    | 0.01    |                  |  |      |        |      |  |  | 0.03    |   |  |  | 0.01    |  
|Diluted  as reported                                                                                                                       |  |                    | 0.01    |                  |  |      |        |      |  |  | 0.04    |   |  |  | 0.02    |  
|Diluted  proforma                                                                                                                          |  |                    | 0.01    |                  |  |      |        |      |  |  | 0.03    |   |  |  | 0.01    |  





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##### Table of Contents



CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

Overview

The Company develops, assembles and markets medical devices that furnish
supplementary oxygen to home health care patients. The Company was a pioneer
in developing oxygen conserving devices that enhance the quality of life for
patients by increasing their mobility and, at the same time, lower operating
costs by achieving significant savings in the amount of oxygen actually
required to properly oxygenate patients. The market for oxygen conserving
devices has been and continues to be significantly affected by increased
competition, consolidation among home oxygen dealers and revisions (and
proposed revisions) in governmental reimbursement policies. All of these
factors, as described more fully below, have contributed to a more competitive
market for the Companys products, as devices that were less expensive but
which provided lower oxygen savings (or, in some cases, did not truly provide
ambulatory oxygen) have achieved some level of success.

The current procedures for reimbursement by Medicare for home oxygen services
provide a prospective flat fee monthly payment based solely on the patients
prescribed oxygen requirement. Under this system, inexpensive concentrators
have grown in popularity because of low coast and less frequent servicing
requirements. At the same time, oxygen conserving devices, such as the
Companys products, have also grown in popularity due to their ability to
extend the life of oxygen supplies and reduce service calls by dealers, thereby
providing improved mobility for the patient and cost savings for dealers.

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. Major national and
regional home medical equipment chains have continued to expand their
distribution networks through the acquisition of independent dealers in
strategic areas. Margins on sales to national chains are generally lower due
to quantity pricing. Four major national chains accounted for approximately
47% and 50% of the Companys net sales, for the six month periods ended
September 30, 2003 and 2002, respectively. One chain accounted for 26% of
sales in both of the six month periods ended September 30, 2003 and 2002,
respectively and one other chain accounted for 15% and 13% of sales in the six
month period ended September 30, 2003 and 2002, respectively.

The Company believes that price competition, continuing industry consolidation
and competitive products with features not found in the Companys products
prior to the introduction of the OM-400 series conservers discussed below
adversely affected sales during the three years ending March 31, 2001. To
combat the erosion in sales of the oxygen conserver product line, the Company
developed and introduced several new
products in this area. The first of these, the OXYMATIC 401 conserver,
received 501 (k) clearance from the Food And Drug Administration in June 2000,
and shipments of the new product began in July 2000. The second, the OXYMATIC
411 conserver, was cleared in December 2000 and shipments began in January
2001. The third, the OXYMATIC 401A and 411A conservers, received clearance in
March 2001 with shipments beginning that month. The SEQUOIA OXYMATIC 300
series conservers





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CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

began shipping in December 2001, and the Company began shipment of CYPRESS
OXYPneumatic conserver in July 2002. Management believes the features and
improvements in these products have enabled the Company to regain some of the
market share lost in the conserver market prior to 2001 and reestablish the
Company as a leader in the conserver market. No estimate can currently be made
regarding the level of success the Company may achieve with these new lines of
conservers. For information that may affect the forward-looking statements
make in this paragraph about new conservers, see Outlook: Issues and Risks
New Products.

In 1998, the Company introduced the TOTAL O2 system, which provides stationary
oxygen for patients at home, portable oxygen, including an oxygen conserving
device for ambulatory use, and a safe and efficient mechanism for filling
portable oxygen cylinders in the home. This provides home care dealers with a
means to reduce their monthly cost of servicing patients while at the same time
providing a higher quality of service by maximizing ambulatory capability. The
Company received clearance in November 1997 from the Food and Drug
Administration to sell this product. Initial sales of the TOTAL O2 system were
adversely affected by several factors, including the overall home oxygen market
climate as well as start-up manufacturing and related supplier quality issues.
The Company has taken a number of steps to resolve the manufacturing and
supplier issues and now believes the success of this product will be dependent
on the healthcare communitys acceptance of this technology and willingness to
substitute a higher capital acquisition cost for lower operating costs. While
the Company will continue its efforts to promote this product, based on current
sales levels, the Company wrote off the unamortized license fees related to the
TOTAL O2 system in March 2003. For information that may affect the outcome of
forward-looking statements made in this paragraph about the TOTAL O2 systems,
see Outlook: Issues and Risks New Products.

As discussed above, during the past two years, the Company has recovered
substantial market share in the conserver market and is using that platform to
spearhead its growth strategy for the future, which includes the following:



| |  | Development of additional oxygen conserver models, such as the CYPRESS
OXYPneumatic conserver introduced in July 2002, that diversify the
product line in order to offer customers a range of oxygen
conservation choices;                                                                                                                                                                                        
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
| |  | A continued promotional and educational campaign with respect to the
benefits of the TOTAL O2 system, coupled with an ongoing emphasis on
improving the performance of component suppliers; 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. These new
technologies will provide the Company with an opportunity to expand its
oxygen conserver product lines and potentially enter the high-growth sleep
disorder market.

While the turnaround measures of the past two years have had a positive impact
and management believes the current growth strategy should continue to enhance
the





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##### Table of Contents



CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

Companys competitive position and future operating performance, no assurances
can be given that these objectives will be achieved. Management of the Company
will continually monitor the success of these efforts and will attempt to
remain flexible in order to adjust to possible future changes in the market for
respiratory care devices.

Results of Operations

Three months ended September 2003 compared to three months ended September 2002

Sales for the three month period ended September 30, 2003 increased by
$444,000(9.2%) compared to the three month period ended September 30, 2002.
The Company has experienced a significant increase in sales of its conservers,
primarily as a result of the introduction of the OXYMATIC 400 series conservers
and CYPRESS OXYPneumatic conserver. Domestic unit sales of conservers for the
three months ended September 30, 2003, increased 21% over the prior year,
while the increase in domestic revenues from conserver sales was 14%. This
resulted from price reductions, the impact of national chain contract pricing
(see above), and the generally lower pricing for pneumatic conservers in the
marketplace.

Sales to foreign distributors represented 4% and 5% of total sales for the
three months ended September 30, 2003 and 2002, respectively. Management
expects an increase in sales to foreign distributors during the upcoming twelve
months, however, quarter-to-quarter sales may fluctuate depending on the timing
of shipments. All foreign sales, with the exception of Canada, are denominated
in US dollars.

Cost of sales as percent of net sales decreased from 57.8% to 55.2% for the
three months ended September 30, 2003 as compared to the same period in the
prior year. This was a result of increased sales volume and the change in the
product mix, as the TOTAL O2 system has a lower gross profit margin than
conservers.

Selling, general and administrative expenditures were $1,868,000 (35.4% of
sales) for the three months ended September 30, 2003, an increase from
$1,808,000 (37.4% of sales) for the three months ended September 30, 2002.

The Companys cost reduction efforts over the past two years have helped align
staffing and operating expenses more closely with current sales expectations,
but were offset to some extent by commissions paid to the Companys field sales
force of manufacturers representatives. Research and development expenses
increased by $120,000 for the three months ended September 30, 2003 as compared
to the same period in the prior year. Currently, management expects research
and development expenditures to total approximately $1, 430,000 in the fiscal
year ending March 31, 2004, on projects to enhance and expand the Companys
product line. Interest income decreased $1,000 for
the period ended September 30, 2003 as compared to the prior year due to the
decrease in cash balance in the current year and reduction in interest rates.





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CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

Six months ended September 2003 compared to six months ended September 2002

Sales for the six month period ended September 30, 2003 increased by $1,091,000
(11.1%) compared to the six month period ended September 30, 2002. The Company
has experienced a significant increase in sales of its conservers, primarily as
a result of the introduction of the OXYMATIC 400 series conservers and CYPRESS
OXYPneumatic conserver. Domestic unit sales of conservers for the six months
ended September 30, 2003, increased 25% over the prior year, while the
increase in domestic revenues from conserver sales was 17%. This resulted from
price reductions, the impact of national chain contract pricing (see above),
and the generally lower pricing for pneumatic conservers in the marketplace.

Sales to foreign distributors represented 5% and 4% of total sales for the six
months ended September 30, 2003 and 2002, respectively. Management expects an
increase in sales to foreign distributors during the upcoming twelve months,
however, quarter-to-quarter sales may fluctuate depending on the timing of
shipments. All foreign sales, with the exception of Canada, are denominated in
US dollars.

Cost of sales as a percent of net sales decreased from 57.6% to 55.4% for the
six months ended September 30, 2003 as compared to the same period in the prior
year. This was a result of increased sales volume and the change in the
product mix, as the TOTAL O2 system has a lower gross profit margin than
conservers.

Selling, general and administrative expenditures were $3,833,000 (35.0% of
sales) for the six months ended September 30, 2003, an increase from $3,508,000
(35.6% of sales) for the six months ended September 30, 2002.

On July 31, 2002, a national chain accounting for less than 10% of sales in
2003 filed a Plan of Reorganization under Chapter 11 of the United States
Bankruptcy Code (the Plan). The Bankruptcy Court has approved the plan and
payments to the unsecured creditors commenced on July 1, 2003. The secured
creditors have appealed to the Bankruptcy Courts decision approving the plan.
No assurance can be given that all of the payments will be made as proposed
under the Plan. As of September 2003, this chain was indebted to the Company
for approximately $204,000, and in October 2003 the Company received payments
of $74,000 against the debt. It is too early to determine what impact, if
any, this reorganization proceeding will have on future sales by the Company to
this chain.

At September 30, 2003, the Company had fully utilized its net operating loss
carrybacks and federal net operating loss carry forwards and had approximately
$2,785,000 in California net operating loss carryforwards. As a result of the
valuation allowances
placed on the net operating loss carryforwards and deferred tax assets, these
net operating loss carryforwards and deferred tax assets will be available to
offset future income tax expense when and if the Company generates additional
taxable income. In September 2002, California enacted legislation that
suspends the utilization of net operating loss carryforwards during tax years
starting 2002 and 2003 effective retroactively back to





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CHAD THERAPEUTICS, INC
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

January 1, 2002. As a result, the Company will be unable to use its California
net operating loss carryforwards until the tax year beginning April 1, 2004.
The company has manufacturing tax credit carryforwards of $46,000 available to
offset future California taxable income.

Financial Condition

At September 30, 2003, the Company had cash totaling $1,083,000 or 9.0% of
total assets, as compared to $1,596,000 (13.0% of total assets) at March 31,
2003. Net working capital increased from $8,224,000 at March 31, 2003 to
$8,680,000 at September 30, 2003. Net accounts receivable increased $243,000
during the six month period ended September 30, 2003, due to the increase in
sales. For information regarding the reorganization proceedings of one of our
customers, please see the discussion in Results of Operations. 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 $483,000. The Company attempts
to maintain sufficient inventories to meet its customer needs as orders are
received. Thus, future inventory and related accounts payable levels will be
impacted by the ability of the Company to maintain its safety stock levels. If
safety stock levels drop below target amounts, then inventories in subsequent
periods will increase more rapidly as inventory balances are replenished.
Currently, inventory balances are generally near safety stock levels.

Management believes cash balances and funds derived from operations should be
adequate to meet the Companys cash requirements for the next twelve months
given the recent recovery of market share of oxygen conservers. Cash derived
from operations will depend on the ability of the Company to maintain
profitable operations and the timing of increases in receivables and
inventories. If profitable operations do not continue, the Company may need to
seek other sources of working capital but currently has no such arrangements in
place and no assurance can be given that if and when needed other sources of
working capital would be available. The Company expects capital expenditures
during the next twelve months to be approximately $600,000.

The Company has not adopted any programs that provide for post employment
retirement benefits, however, it has on occasion provided such benefits to
individual employees. The Company does not have any off balance sheet
arrangements with any special purpose entities or any other parties, does not
enter into any transactions in derivatives and has no material transactions
with any related parties.

Significant Accounting Policies

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
significantly from those estimates under different assumptions and





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CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

conditions. Management believes that the following discussion addresses the
accounting policies and estimates that are most important in the portrayal of
the Companys financial condition and results.

Allowance for doubtful accounts  the Company provides a reserve against
receivables for estimated losses that may result from our customers inability
to pay. The amount of the reserve is based on an analysis of known
uncollectible accounts, aged receivables, historical losses, and
credit-worthiness. Amounts later determined and specifically identified to be
uncollectible are charged or written off against this reserve. The likelihood
of material losses is dependent on general economic conditions and numerous
factors that affect individual accounts.

Inventories  the Company provides a reserve against inventories for excess and
slow moving items. The amount of the reserve is based on an analysis of the
inventory turnover for individual items in inventory. The likelihood of
material write-downs is dependent on customer demand and competitor product
offerings.

Intangible and long-lived assets  The Company assesses whether or not there
has been an impairment of intangible and long-lived assets in evaluating the
carrying value of these assets. Assets are considered impaired if the carrying
value is not recoverable over the useful life of the asset. If an asset is
considered impaired, the amount by which the carrying value exceeds the fair
value of the asset is written off. The likelihood of a material change in the
Companys reported results is dependent on each assets ability to continue to
generate income, loss of legal ownership or title to an asset and the impact of
significant negative industry or economic trends.

Deferred income taxes  the Company provides a valuation allowance to reduce
deferred tax assets to the amount expected to be realized. The likelihood of a
material change in the expected realization of these assets depends on the
Companys ability to generate future taxable income.

Outlook: Issues & Risks

The 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 form 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.





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##### Table of Contents



CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

New Products

The Companys future growth in the near term will depend in significant part
upon its ability to successfully introduce new products. In recent years, the
Company has introduced the OXYMATIC 400 series, the SEQUOIA and CYPRESS
OXYPneumatic conservers, and the TOTAL O2 Delivery System; the Company is
currently developing additional new products. The success of these products
will depend upon the health care communitys perception of such products
capabilities, clinical efficacy and benefit to patients as well as obtaining
timely regulatory approval. In addition, prospective sales will be impacted by
the degree of acceptance achieved among home oxygen dealers and patients
requiring supplementary oxygen. As with any product, the Companys ability to
successfully promote the OXYMATIC 400, SEQUOIA and CYPRESS OXYPneumatic series
conservers, the TOTAL O2 Delivery System and other new products cannot be
determined 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. Four major national chains accounted for 47% of the
Companys net sales during the period ended September 30, 2003.

For information regarding the reorganization proceedings of one our customers,
please see the discussion in Results of Operations. Future sales may be
increasingly dependent on a limited number of customers, which may have an
impact on margins due to quantity pricing.

Competition

Chads success in the early 1990s has drawn competition to vie for a share of
the home oxygen market. These new competitors include both small and very
large companies. While the Company believes the quality of its products and
its established reputation will continue to be a competitive advantage, some
competitors have successfully introduced lower priced products that do not
provide oxygen conserving capabilities comparable to the Companys products.
Most of these competitors have greater capital resources than the Company. No
assurance can be given that increased competition in the home oxygen market
will not have an adverse affect on the Companys operations.

Rapid Technological Change

The health care industry is characterized by rapid technological change. The
Companys products may become obsolete as a result of new developments. The
Companys ability to remain competitive will depend to a large extent upon its
ability to anticipate and stay abreast of new technological developments
related to oxygen therapy. The Company has limited internal research and
development capabilities. Historically, the Company has contracted with
outside parties to develop new products. Some of the Companys





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CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

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 such bills have
been introduced in Congress, including various proposals for competitive
bidding, and various state legislatures. Because of the uncertain state of
health care proposals, it is not meaningful at this time to predict the effect
on the Company if any of these proposals is enacted.

Approximately 80% of home oxygen patients are covered by Medicare and other
government programs. Federal law has altered the payment rates available to
providers of Medicare services in various ways during the last several years.
Congress has passed legislation, which has reduced Medicare spending. It
cannot yet be predicted how future changes in reimbursement levels will affect
the home oxygen industry and there can be no assurance that such changes will
not have an adverse affect on the Companys business.

Protection of Intellectual Property Rights

The Company pursues a policy of protecting its intellecutal property rights
through a combination of patents, trademarks, trade secret laws and
confidentiality agreements. The Company considers the protection of its
proprietary rights and the patentability of it products to be significant to
the success of the Company. To the extent that the products to be marketed by
the Company do not receive patent protection, competitors may be able to
manufacture and market substantially similar products. Such competition or
claims that the Companys products infringe the patent rights of others could
have an adverse impact upon the Companys business.

Product Liability

The nature of the Companys business subjects it to potential legal actions
asserting that the Company is liable for damages for product liability claims.
Although the Company maintains product liability insurance in an amount which
it believes to be customary in the industry, there is no assurance that this
insurance will be sufficient to cover the cots of defense or judgments which
might be entered against the Company. The type and frequency of these claims
could have an adverse impact on the Companys results of operations and
financial position.

Availability and Reliability of Third Party Component Products

The Company tests and packages its products in its own facility. Some of its
other manufacturing processes are conducted by other firms; the Company expects
to continue using outside firms for certain manufacturing processes for the
foreseeable future and is thus dependent on the reliability and quality of
parts supplied by these firms. From time to time, the Company has experienced
problems with the reliability of components





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CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

produced by third party suppliers. 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 parts required for its products.

Accounting Standards

Accounting standards promulgated by the Financial Accounting Standards Board
change periodically. Changes in such standards may have an impact on the
Companys future financial position.

In October 2001, the Financial Accounting Standards Board issued FASB Statement
No. 144, Accounting for the Impairment or Disposal of
Long-Live Assets, which
addresses financial accounting and reporting for the impairment of disposal of
long-lived assets. While Statement No. 144 supersedes FASB Statement No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, it retains many of the fundamental provisions of that
Statement. The Company adopted the provisions of Statement 144 effective April
1, 2002. During 2003, the Company wrote-off the remaining unamortized balance
of an intangible license fee asset in the amount of $934,000 in accordance with
Statement No. 144.

In July 2002, the FASB issued Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. This standard requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of commitment to an exit or disposal plan.
This statement is effective prospectively to exit or disposal activities
initiated after December 31, 2002. We adopted SFAS 146 effective August 1,
2002, and the adoption of this standard did not have an impact on our financial
statements.

In November 2002, the FASB issued Interpretation Number 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN 45). This interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual
financial statements about its obligations under certain guarantees that it has
issued. It also clarifies that the guarantor is required to recognize, at the
inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The disclosure requirements of FIN 45 are
effective for interim and annual periods after December 15, 2002. We adopted
FIN 45 effective January 1, 2003 and the adoption of FIN 45 did not have a
material impact on the Companys financial statements.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure  an amendment of FASB Statement No.
123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation
to provice alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require prominent





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CHAD THERAPEUTICS, INC.
Managements Discussion and Analysis of
Financial Condition and Results of Operations

September 30, 2003

disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The disclosure requirements apply to all companies
for fiscal years ending after December 15, 2002. The interim disclosure
provisions are effective for financial reports containing financial statements
for interim periods beginning after December 15, 2002. The adoption of SFAS No.
148 did not have a material impact on the Companys financial statements.

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.




Item 4. Controls and Procedures

The Company has evaluated the effectiveness of the design and operation of its
disclosure controls and procedures as of September 30, 2003 (the Evaluation
Date). Such evaluation was conducted under the supervision and with the
participation of the Companys Chief Executive Officer (CEO) and its Chief
Financial Officer (CFO). Based upon such evaluation, the Companys CEO and
CFO have concluded that, as of the Evaluation Date, the Companys disclosure
controls and procedures were effective. There have been no significant changes
in the Companys internal control over financial reporting that occurred during
the Companys most recent fiscal quarter that have materially affected, or are
reasonably likely to materially affect, the Companys internal control over
financial reporting.




Part II




Item 6. Exhibits and Reports on Form 8-K

(a) 31.1 Certification pursuant
to Section 302 of Sarbanes-Oxley for CEO
(b) 31.2 Certification pursuant to Section 302 of
Sarbane-Oxley for CFO
(c) 32     Certification pursuant to 18 U.S.C Section 1350

Reports on Form 8-K:

Item 9. Press release regarding first quarter operating results filed
August 11, 2003





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##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|              |  |                                                 
|------------- |  | ------------------------------------------------
|              |  | CHAD THERAPEUTICS, Inc.
(Registrant)            
|              |  |                                                 
|Date 10/31/03 |  | /S/ Thomas E. Jones                             
|              |  |                                                 
|              |  | Thomas E. Jones                                 
|              |  | Chairman and Chief Executive Officer            
|              |  |                                                 
|Date 10/31/03 |  | /S/ Earl L. Yager                               
|              |  |                                                 
|              |  | Earl L. Yager                                   
|              |  | President, Chief Financial Officer and Secretary