##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934 [X]    For Quarterly Period Ended: June 30, 2004 Or [  ]    Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 Commission file number: 1-12214 CHAD THERAPEUTICS, INC. 
  California
    
    95-3792700(State of other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 21622 Plummer Street, Chatsworth, CA 91311 
  (818) 882-0883 
     (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.  Indicate by check whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act.)  Ax of June 30, 2004, the registrant had 10,122,000 shares of its commons stock
outstanding.




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TABLE OF CONTENTS  Condensed Balance SheetsCondensed Statements of OperationsCondensed Statement of Shareholders EquityCondensed Statements of Cash FlowsNotes to Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and Results of OperationItem 3. Quantitative and Qualitative Disclosures abut Market RisksItem 4. Controls and ProceduresPart IIItem 1. Legal ProceedingsItem 2. Changes is Securities, Use of Proceeds and Issuer Purchase of Equity SecuritiesItem 3. Defaults Upon Senior SecuritiesItem 4. Submission of Matters to a Vote of Security HoldersItem 5. Other InformationItem 6. Exhibits and Reports on Form 8-KINDEX TO EXHIBITSExhibit 31.1Exhibit 31.2Exhibit 32    Table of Contents  
 CHAD THERAPEUTICS, INC.
Condensed Balance Sheets
June 30, 2004 and March 31, 2004
(Unaudited) June 30,
    
    March 31,2004
    
    2004ASSETSCurrent Assets:Cash
    
    $
    3,475,000
    
    
    $
    2,708,000Accounts receivable, less allowance for
doubtful accounts of $57,000 at
June 30, 2004 and $68,000 at
March 31, 2004
    
    
    3,074,000
    
    
    
    2,911,000Inventories (Note 2)
    
    
    4,773,000
    
    
    
    4,989,000Prepaid Expenses
    
    
    138,000
    
    
    
    233,000Deferred income taxes
    
    
    224,000
    
    
    
    224,000Total current assets
    
    
    11,684,000
    
    
    
    11,065,000Property and equipment, at cost
    
    
    5,841,000
    
    
    
    5,789,000Less accumulated depreciation
    
    
    4,666,000
    
    
    
    4,571,000Net property and equipment
    
    
    1,175,000
    
    
    
    1,218,000Intangible assets, net
    
    
    719,000
    
    
    
    729,000Other assets, net
    
    
    56,000
    
    
    
    31,000Total assets
    
    $
    13,634,000
    
    
    $
    13,043,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    811,000
    
    
    $
    502,000Accrued expenses
    
    
    1,307,000
    
    
    
    1,185,000Income taxes payable
    
    
    63,000
    
    
    
    203,000Total current liabilities
    
    
    2,181,000
    
    
    
    1,890,000Shareholders equity:Common shares, $.01 par value, authorized
40,000,000 shares; 10,122,000 and 10,096,000
shares issued and outstanding
    
    
    13,347,000
    
    
    
    13,309,000Accumulated deficit
    
    
    (1,894,000
    )
    
    
    (2,156,000
    )Total shareholders equity
    
    
    11,453,000
    
    
    
    11,153,000Total liabilities and shareholders equity
    
    $
    13,634,000
    
    
    $
    13,043,000
 See accompanying notes to condensed financial statements.




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CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the three months ended June 30, 2004 and 2003
(Unaudited) Three Months EndedJune 30,2004
    
    2003Net Sales
    
    $
    6,099,000
    
    
    $
    5,669,000Cost of Sales
    
    
    3,553,000
    
    
    
    3,151,000Gross profit
    
    
    2,546,000
    
    
    
    2,518,000Costs and expenses:Selling, general and administrative
    
    
    1,862,000
    
    
    
    1,965,000Research and development
    
    
    410,000
    
    
    
    323,000Total costs and expenses
    
    
    2,272,000
    
    
    
    2,288,000Operating income
    
    
    274,000
    
    
    
    230,000Other Income
    
    
    8,000
    
    
    
    5,000Earnings before income taxes
    
    
    282,000
    
    
    
    235,000Income tax expense
    
    
    20,000
    
    
    
    11,000Net earnings
    
    $
    262,000
    
    
    $
    224,000Basic earnings per share
    
    $
    0.03
    
    
    $
    0.02Diluted earnings per share
    
    $
    0.02
    
    
    $
    0.02Weighted shares outstanding:Basic
    
    
    10,110,000
    
    
    
    10,076,000Diluted
    
    
    10,617,000
    
    
    
    10,254,000
 See accompanying notes to condensed financial statements.




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CHAD THERAPEUTICS, INC.
Condensed Statement of Shareholders Equity
For the three months ended June 30, 2004
(Unaudited) Common Shares
    
    AccumulatedShares
    
    Amount
    
    DeficitBalance as of March 31, 2004
    
    
    10,096,000
    
    
    $
    13,309,000
    
    
    $
    (2,156,000
    )Exercise of stock options
    
    
    26,000
    
    
    
    38,000
    
    
    
    Net earnings
    
    
    
    
    
    
    
    
    
    
    262,000Balance at June 30, 2004
    
    
    10,122,000
    
    
    $
    13,347,000
    
    
    $
    (1,894,000
    )




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CHAD THERAPEUTICS, INC.
Condensed Statements of Cash Flows
For the three months ended June 30, 2004 and 2003
(Unaudited) Three Months EndedJune 30,2004
    
    2003Cash flows from operating activities:Net earnings
    
    $
    262,000
    
    
    $
    224,000Adjustments to reconcile net earnings to net cash
provided by operating activities:Depreciation and amortization of property and
equipment
    
    
    95,000
    
    
    
    161,000Amortization of intangibles
    
    
    10,000
    
    
    
    Changes in assets and liabilities:Decrease (increase) in accounts receivable
    
    
    (163,000
    )
    
    
    (429,000
    )Decrease (increase) in inventories
    
    
    216,000
    
    
    
    (291,000
    )Decrease (increase) in prepaid expenses
    
    
    95,000
    
    
    
    146,000Decrease (increase) in other assets
    
    
    (25,000
    )
    
    
    (95,000
    )Increase (decrease) in accounts payable
    
    
    309,000
    
    
    
    60,000Increase (decrease) in accrued expenses
    
    
    122,000
    
    
    
    134,000Increase (decrease) in income taxes payable
    
    
    (140,000
    )
    
    
    8,000Net cash provided by operating activities
    
    
    781,000
    
    
    
    (82,000
    )Cash flows from investing activities:Additions to other assets
Capital expenditures
    
    
    (52,000
    )
    
    
    (83,000
    )Net cash used in investing activities
    
    
    (52,000
    )
    
    
    (83,000
    )Cash flows from financing activities:Exercise of stock options
    
    
    38,000
    
    
    
    Net cash provided by financing activities
    
    
    38,000
    
    
    
    Net increase (decrease) in cash
    
    
    767,000
    
    
    
    (165,000
    )Cash beginning of period
    
    
    2,708,000
    
    
    
    1,596,000Cash end of period
    
    $
    3,475,000
    
    
    $
    1,431,000
 See accompanying notes to condensed financial statements.




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CHAD THERAPEUTICS, INC.
Notes to Financial Statements
June 30, 2004
(Unaudited)  1.
    
    Interim ReportingCHAD 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 month
period ended June 30, 2004, are not necessarily indicative of the results
expected for the year ended March 31, 2005. 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, 2004, Annual
Report and particularly to Note 1 which includes a summary of significant
accounting policies.2.
    
    InventoriesInventories in 2004 are summarized as follows: June 30
    
    March 31Finished goods
    
    $
    1,405,000
    
    
    $
    1,223,000Work-in-process
    
    
    1,082,000
    
    
    
    1,062,000Raw materials
    
    
    2,286,000
    
    
    
    2,704,000$
    4,773,000
    
    
    $
    4,989,000




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CHAD THERAPEUTICS, INC.
Notes to Financial Statements
June 30, 2004
(Unaudited)  3.
    
    Earnings Per Common ShareFollowing is a reconciliation of the numerators and denominators used in the
calculation of basic and diluted earnings per common shares: Three Months Ended June 30,2004
    
    2003Basic earnings per share:Numerator-net earnings
    
    $
    262,000
    
    
    $
    224,000Denominator-weighted average
common shares outstanding
    
    
    10,110,000
    
    
    
    10,076,000Basic earnings per share
    
    $
    0.03
    
    
    $
    0.02Diluted earnings per share:Numerator-net earnings
    
    $
    262,000
    
    
    $
    224,000Denominator:Weighted average common shares
outstanding
    
    
    10,110,000
    
    
    
    10,076,000Diluted effect of common stock options
    
    
    507,000
    
    
    
    178,00010,617,000
    
    
    
    10,254,000Diluted earnings per share
    
    $
    0.02
    
    
    $
    0.02
  Options to purchase 246,000 shares of common stock at prices ranging from
$5.00 to $12.54 per share and 551,000 shares of common stock at prices
ranging from $1.69 to $13.47 were not included in the computation of diluted
earnings per share for the three month periods ended June 30, 2004 and 2003,
respectively, because their effect would have been anti-dilutive.4.
    
    Income Tax ExpenseAt June 30, 2004, the Companys net deferred tax assets are partially offset
by a valuation allowance. The Company will continue to assess the valuation
allowance and to the extent it is determined that such allowance is no longer
required, the tax benefit of the remaining net deferred tax assets will be
recognized in the future. The Company has California net operating loss
carryforwards of $2,785,000, against which a full valuation allowance has
been recorded. California has suspended the utilization of net operating loss
carryforwards during tax years starting in 2002 and 2003. 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 California net operating
losses expire in 2006.




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CHAD THERAPEUTICS, INC.
Notes to Financial Statements
June 30, 2004
(Unaudited)  5.
    
    Geographic InformationThe Company has one reportable operating segment. Geographic information
regarding the Companys sales is as follows: Three Months EndedJune 30,2004
    
    2003United States
    
    $
    5,810,000
    
    
    $
    5,416,000Canada
    
    
    81,000
    
    
    
    95,000Germany
    
    
    1,000
    
    
    
    41,000Japan
    
    
    83,000
    
    
    
    38,000All other countries
    
    
    124,000
    
    
    
    79,000$
    6,099,000
    
    
    $
    5,669,000
  All long-lived assets are located in the United States.Sales of OXYMATIC® and CYPRESS OXYPneumatic® conservers accounted for 76% and
77% of the Companys sales for the three month periods ended June 30, 2004
and 2003, respectively.6.
    
    Stock Option PlanThe 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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CHAD THERAPEUTICS, INC.
Notes to Financial Statements
June 30, 2004
(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 and earnings 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 EndedJune 30,2004
    
    2003Net earnings, as reported
    
    $
    262,000
    
    
    $
    224,000Deduct: Total stock based employee
compensation expense determined under
fair value-based method for all awards, net
of related tax effects
    
    
    37,000
    
    
    
    29,000Pro forma net income (loss)
    
    $
    225,000
    
    
    $
    195,000Earnings per share:Basic  as reported
    
    $
    0.03
    
    
    $
    0.02Basic  pro forma
    
    
    0.02
    
    
    
    0.02Diluted  as reported
    
    
    0.02
    
    
    
    0.02Diluted  proforma
    
    $
    0.02
    
    
    $
    0.02




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operation Overview CHAD Therapeutics, Inc. (the Company) develops, assembles and markets medical
devices that furnish supplementary oxygen to home health care patients. The
Company was a pioneer in developing oxygen conserving devices that enhance the
quality of life for patients by increasing their mobility and, at the same
time, lower operating costs by achieving significant savings in the amount of
oxygen actually required to properly oxygenate patients. The market for oxygen
conserving devices has been and continues to be significantly affected by
increased competition, consolidation among home oxygen dealers and revisions
(and proposed revisions) in governmental reimbursement policies. All of these
factors, as described more fully below, have contributed to a more competitive
market for the 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 cost 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 and management anticipates continued downward pressure on
its average selling price. Four major national chains accounted for
approximately 53% and 47% of the Companys net sales, for the three month
periods ended June 30, 2004 and 2003, respectively. One chain accounted for
32% and 23% of sales for the three month periods ended June 30, 2004 and 2004,
respectively, and one other chain accounted for 16% and 14% of sales for the
three month periods ended June 30, 2004 and 2003, 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 and CYPRESS OXYPneumatic® 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




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clearance in March 2001 with shipments beginning that month. The SEQUOIA
OXYMATIC 300 series conservers began shipping in December 2001, and the Company
began shipment of 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. In May of 2004, the Company received clearance from the FDA to market its new
SAGE Oxygen Therapeutic Device. The SAGE device is the first in a planned
family of oxygen therapeutic devices that use the Companys proprietary
technologies to sense a patients movements and automatically adjust the rate
of oxygen delivery to reduce the risk of desaturation as activity increases.
This device combines the industrys first truly dynamic delivery technology
with the proven oxygen sensor technology in the OXYMATIC 400 series conservers.
As a result, the new SAGE Oxygen Therapeutic Device addresses the common
problem of oxygen desaturation, which causes a patient to feel weak and out of
breath when activity increases, while it still improves patient ambulatory
capability. This new device underscores the Companys dedication to providing
home care suppliers and their patients with the widest range of home oxygen
choices to suit individual needs, preferences and disease conditions. The
Company has received purchase orders that will consume its SAGE production
capability through January 2005. No estimate can currently be made regarding
the level of success the Company may achieve with this line of products or when
the additional therapeutic devices that are now in development and which are
based on this advanced new platform may be introduced to the market. For
information that may affect the forward-looking statements made in this
paragraph about products under development, see Outlook: Issues and Risks  New
Products, Manufacture of SAGE Oxygen Therapeutic Device. In 1998, the Company introduced the TOTAL O2® Delivery System, which provides
stationary oxygen for patients at home, portable oxygen, including an oxygen
conserving device for ambulatory use, and a safe and efficient mechanism for
filling portable oxygen cylinders in the home. This provides home care dealers
with a means to reduce their monthly cost of servicing patients while at the
same time providing a higher quality of service by maximizing ambulatory
capability. The Company received clearance in November 1997 from the Food and
Drug Administration to sell this product. Initial sales of the TOTAL O2 system
were adversely affected by several factors, including the overall home oxygen
market climate as well as 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 sales levels through March of 2003, the Company wrote off the
unamortized license fees related to the TOTAL O2 system in March 2003. During the past three 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:




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
    
    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;
    
    An effort to expand the Companys product lines and improve existing
products through the investment in and development of new
technologies, such as proprietary sensor technology and control
software licensed in January of 2003 and the introduction of the SAGE
Oxygen Therapeutic Device in May 2004. These new technologies will
provide the Company with an opportunity to expand its oxygen delivery
product lines and potentially enter the high-growth sleep disorder
market.
    
    A continued promotional and education campaign with respect to the
benefits of the TOTAL O2 system, coupled with an ongoing emphasis on
improving the performance of component suppliers. While the turnaround measures of the past three years have had a positive
impact and management believes the current growth strategy should continue to
enhance the Companys competitive position and future operating performance, no
assurances can be given that these objectives will be achieved. Management of
the Company will continually monitor the success of these efforts and will
attempt to remain flexible in order to adjust to possible future changes in the
market for respiratory care devices. For information that may affect the
outcome of forward-looking statements in this Overview regarding the Companys
business strategy and its introduction of new products, see Outlook: Issues
and Risks  New Products, Consolidation of Home Care Industry, Competition,
Rapid Technological Change, and Potential Changes in the Administration of
Health Care, beginning on page 16 of this Report. Results of
Operations

Sales for the three month period ended June 30, 2004 increased by $430.000
(7.6%) as compared to the same period in the prior year. The primary driver of
the Companys increase in sales has been the significant growth in sales of its
conservers, largely as a result of the introduction of the OXYMATIC 400 series
conservers and CYPRESS OXYPneumatic conserver. Management believes that the
performance features of these conservers have enabled the Company to recapture
significant market share. Domestic unit sales of conservers for the three
month period ended June 30, 2004, increased 39%, over the prior year, while
the increase in domestic revenues from conserver sales was 5%. 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 4.7% and 4.4% of total sales for the
three month periods ended June 30, 2004 and 2003, 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. Sales in Canada represent less than 2% of total sales. Cost of sales as a percent of net sales increased from 55.6% to 58.3% for the
three month period ended June 30, 2004 as compared to the prior year period.
This was a result of national chain contract pricing and pricing pressure
resulting from the recently enacted Medicare Improvement and Modernization Act.
The Company has negotiated cost




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reductions with its suppliers, which should result in cost savings that will
offset continued pressure on pricing. Selling, general and administrative expenditures decreased from 34.7% to 30.5%
of net sales for the three month period ended June 30, 2004, as compared to the
same period in the prior year. 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 $87,000 for the three month
period ended June 30, 2004, as compared to the prior year. Currently,
management expects research and development expenditures to total approximately
$1,570,000 in the fiscal year ending March 31, 2005, on projects to enhance and
expand the Companys product line. 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 Plan provided for full repayment to the
Company, and the Bankruptcy Court has approved the Plan. Payments to the
unsecured creditors commenced on July 1, 2003. No assurance can be given that
all of the payments will be made as proposed under the Plan. As of June 30,
2004, this chain was indebted to the Company for approximately $89,000, and in
July 2004, the Company received payments of $45,000 against the debt. At June 30, 2004, the Companys net deferred tax assets are partially offset by
a valuation allowance. The Company will continue to assess the valuation
allowance and to the extent it is determined that such allowance is no longer
required, the tax benefit of the remaining net deferred tax assets will be
recognized in the future. The Company has California net operating loss
carryforwards of $2,785,000, against which a full valuation allowance has been
recorded. California has suspended the utilization of net operating loss
carryforwards during tax years starting in 2002 and 2003. 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 California net operating
losses expire in 2006. Financial Condition At June 30, 2004, the Company had cash totaling $3,475,000 or 25.5% of total
assets, as compared to $2,708,000 (20.8% of total assets) at March 31, 2004.
Net working capital increased from $9,175,000 at March 31, 2004 to $9,503,000
at June 30, 2004. Net accounts receivable increased $163,000 during the three
months ended June 30, 2004, 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 decreased $216,000. 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. The Company depends upon its cash flow from operations to meet its capital
requirements. Management believes cash balances and funds derived from
operations




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should be adequate to meet the Companys near and long term cash requirements
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. The Company has no established lines of
credit or other arrangements in place to obtain working capital 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 $1,250,000. The following table aggregates all of the Companys material contractual
obligations as of June 30, 2004: Payments Due by PeriodLess than 1
    
    1  3
    
    3-5
    
    After 5Total
    
    Year
    
    Years
    
    Years
    
    YearsContractual Cash Obligations
Operating lease
obligations
    
    
    1,731,000
    
    
    
    406,000
    
    
    
    1,309,000
    
    
    
    16,000
    
    
    
    
 Operating lease commitments consist primarily of a real property lease for the
Companys corporate office, as well as minor equipment leases. Payments for
these lease commitments are provided for by cash flows generated from
operations. Please see Note 8 to the financial statements in the 2004 Annual
Report. The Company does not have any debt and is not subject to any covenants or
contractual restrictions limiting its operations. The Company has not adopted
any programs that provide for post employment retirement benefits, however, it
has on occasion provided such benefits to individual employees. The Company
does not have any off balance sheet arrangements with any special purpose
entities or any other parties, does not enter into any transactions in
derivatives and has no material transactions with any related parties. Critical Accounting Policies The preparation of financial statements in conformity with 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 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




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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 from currently,
anticipated results. Among the factors that could cause actual results to
differ materially are the following: Dependence Upon a Single Product Line Although the Company currently markets a number of products, these products
comprise a single product line for patients requiring supplementary oxygen.
The Companys future performance is thus dependent upon developments affecting
this segment of the health care market and the Companys ability to remain
competitive within this market sector. 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 and in May 2004
introduced the SAGE Oxygen Therapeutic Device; the Company is currently
developing additional new products. The success of the Companys 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 for new products. 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 new products cannot be determined at
this time.




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Manufacture of SAGE Oxygen Therapeutic Device In May 2004, CHAD received clearance for the FDA to market the SAGE Oxygen
Therapeutic Device. Customer response to this new product has been positive
and the Company has received purchase orders that will consume its SAGE product
capability through January 2005. As the Company ramps its production
capabilities to meet demand for the SAGE device, it may encounter difficulties
in securing components, scaling production facilities or other aspects of
managing growth in manufacturing operations. Unexpected problems or costs
could adversely affect the Companys gross profit margins or its ability to
meet customer demand on a timely basis. 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 53% of the
Companys net sales during the year ended March 31, 2004. Future sales may be
increasingly dependent upon a limited number of customers, which may reduce our
average selling price due to quantity pricing. For information regarding the reorganization proceedings of one of our
customers, please see the discussion in Results of Operations. Competition The Company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 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




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of Medicare services in various ways during the last several years. In
November of 2003, Congress enacted the Medicare Improvement and Modernization
Act, which will cause changes and reductions in home oxygen reimbursement over
the next several years. These changes in reimbursement will cause increased
downward pressure on the average selling price of the Companys products. Protection of Intellectual Property Rights The Company pursues a policy of protecting its intellectual property rights
through a combination of patents, trademarks, trade secret laws and
confidentiality agreements. The Company considers the protection of its
proprietary rights and the patentability of its products to be significant to
the success of the Company. To the extent that the products to be marketed by
the Company do not receive patent protection, competitors may be able to
manufacture and market substantially similar products. Such competition or
claims that the Companys products infringe the patent or trademark 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 cost 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 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 June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations (SFAS No. 143), SFAS No. 143 requires the Company to record the
fair value of an asset retirement obligation as a liability in the period in
which it incurs a legal obligation associated with the retirement of tangible
long-lived assets that result from the acquisition, construction, development
and/or normal use of the assets. The Company adopted SFAS No. 143 on April 1,
2003. The Company does not currently have any assets affected by SFAS No. 143.




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In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
which requires that the extinguishment of debt not be considered an
extraordinary item under APB Opinion No. 30, Reporting the Results of
Operations  Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,
unless the debt extinguishment meets the unusual in nature and infrequency of
occurrence criteria in APB 30. SFAS No. 145 is effective for fiscal years
beginning after May 15, 2002. The Company adopted SFAS No. 145 on April 1,
2003 and there was no material impact on the Companys financial condition or
results of operations. In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51. This
Interpretation addresses the consolidation by business enterprises of variable
interest entities as defined in the Interpretation. The Interpretation
generally applies immediately to variable interests in variable interest
entities created after January 31, 2003 and to variable interests in variable
interest entities obtained after January 31, 2003. The application of this
Interpretation did not have a material effect on the Companys financial
statements. In December 2003, the FASB revised FIN 46 to exempt certain
entities from its requirements and to clarify certain issues arising during the
implementation of FIN 46. The adoption of this revised interpretation did not
have any impact on our financial statements. In May 2003, the Financial Accounting Standards Board issued Statement No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (SFAS No. 150). The statement establishes standards for
how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). It is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. We adopted
this standard effective July 1, 2003, and it did not have a material effect 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 3. Quantitative and Qualitative Disclosures abut Market Risks The Company has no significant exposure to market risk sensitive instruments or
contracts. 
 Item 4. Controls and Procedures The Company has evaluated the effectiveness of the design and operation of its
disclosure controls and procedures as of June 30, 2004 (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).




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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
Other Information 
 Item 1. Legal Proceedings None. 
 Item 2. Changes is Securities, Use of Proceeds and Issuer Purchase of Equity
Securities None. 
 Item 3. Defaults Upon Senior Securities Not applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders through the solicitation
of proxies or otherwise during the first quarter ended June 30, 2004. 
 Item 5. Other Information None. 
 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 Sarbanes-Oxley for CFO
(c) 32 Certification pursuant to 18 U.S.C Section 1350 Reports on Form 8-K: None




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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
08/11/04
    
    /s/ Earl L. YagerEarl L. YagerPresident and Chief Executive OfficerDate
08/11/04
    
    /s/ Tracy A. KernTracy A. KernChief Financial Officer




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INDEX TO EXHIBITS Exhibit No.
    
    Description of Exhibits31.1
    
    Certification pursuant to Section 302 of Sarbanes-Oxley for CEO31.2
    
    Certification pursuant to Section 302 of Sarbanes-Oxley for CFO32
    
    Certification pursuant to 18 U.S.C Section 1350