##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934For Quarterly Period Ended: December 31, 2007
 Or
 o
    
    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.)
  (Address of principal executive offices)   (Zip Code)
  (Registrants telephone number, including area code)
 
   þ o
  Large accelerated filer
o
    
    Accelerated filer o
    
    Non-accelerated filer  
þ
(Do not check if a smaller reporting company)
    
    Smaller Reporting Company o
 o þ




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##### Table of Contents



December 31,
    
    
    March 31,2007
    
    
    2007ASSETSCurrent assets:Cash
    
    $
    261,000
    
    
    $
    375,000Accounts receivable, less allowance for
doubtful accounts of $25,000 at
December 31, 2007, and $38,000 at
March 31, 2007
    
    
    1,470,000
    
    
    
    2,376,000Income taxes refundable
    
    
    2,000
    
    
    
    291,000Inventories (Note 5)
    
    
    6,140,000
    
    
    
    6,557,000Prepaid expenses and other assets
    
    
    319,000
    
    
    
    321,000Total current assets
    
    
    8,192,000
    
    
    
    9,920,000Property and equipment, at cost
    
    
    6,337,000
    
    
    
    6,186,000Less accumulated depreciation
    
    
    5,726,000
    
    
    
    5,501,000Net property and equipment
    
    
    611,000
    
    
    
    685,000Intangible assets, net
    
    
    1,071,000
    
    
    
    1,107,000Other assets
    
    
    262,000
    
    
    
    36,000Total assets
    
    $
    10,136,000
    
    
    $
    11,748,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,507,000
    
    
    $
    1,282,000Accrued expenses
    
    
    1,090,000
    
    
    
    1,372,000Revolving line of credit
    
    
    1,168,000
    
    
    
    Current portion of long-term debt
    
    
    292,000
    
    
    
    Total current liabilities
    
    
    4,057,000
    
    
    
    2,654,000Long-term debt
    
    
    390,000
    
    
    
    Total liabilities
    
    
    4,447,000
    
    
    
    2,654,000Shareholders equity:Common shares, $.01 par value, authorized
40,000,000 shares; 10,180,000 and 10,180,000 shares issued and outstanding
    
    
    13,632,000
    
    
    
    13,526,000Accumulated deficit
    
    
    (7,943,000
    )
    
    
    (4,432,000
    )Total shareholders equity
    
    
    5,689,000
    
    
    
    9,094,000Total liabilities and shareholders equity
    
    $
    10,136,000
    
    
    $
    11,748,000




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##### Table of Contents



Three Months EndedDecember 31,2007
    
    
    2006Net sales
    
    $
    2,929,000
    
    
    $
    4,307,000Cost of sales
    
    
    1,770,000
    
    
    
    3,248,000Gross profit
    
    
    1,159,000
    
    
    
    1,059,000Costs and expenses:Selling, general, and administrative
    
    
    1,537,000
    
    
    
    1,421,000Research and development
    
    
    359,000
    
    
    
    396,000Total costs and expenses
    
    
    1,896,000
    
    
    
    1,817,000Operating loss
    
    
    (737,000
    )
    
    
    (758,000
    )Interest expense
    
    
    131,000
    
    
    
    Other income
    
    
    
    
    
    
    18,000Loss before income taxes
    
    
    (868,000
    )
    
    
    (740,000
    )Income tax expense (benefit)
    
    
    
    
    
    
    (305,000
    )Net loss
    
    $
    (868,000
    )
    
    $
    (435,000
    )Basic loss per share
    
    $
    (0.09
    )
    
    $
    (0.04
    )Diluted loss per share
    
    $
    (0.09
    )
    
    $
    (0.04
    )Weighted shares outstanding:Basic
    
    
    10,180,000
    
    
    
    10,169,000Diluted
    
    
    10,180,000
    
    
    
    10,169,000




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##### Table of Contents



Nine Months EndedDecember 31,2007
    
    
    2006Net sales
    
    $
    10,108,000
    
    
    $
    14,766,000Cost of sales
    
    
    7,555,000
    
    
    
    10,276,000Gross profit
    
    
    2,553,000
    
    
    
    4,490,000Costs and expenses:Selling, general, and administrative
    
    
    4,494,000
    
    
    
    4,805,000Research and development
    
    
    1,212,000
    
    
    
    1,053,000Total costs and expenses
    
    
    5,706,000
    
    
    
    5,858,000Operating loss
    
    
    (3,153,000
    )
    
    
    (1,368,000
    )Interest expense
    
    
    306,000
    
    
    
    Other (income) expense
    
    
    48,000
    
    
    
    (57,000
    )Loss before income taxes
    
    
    (3,507,000
    )
    
    
    (1,311,000
    )Income tax expense (benefit)
    
    
    4,000
    
    
    
    (453,000
    )Net loss
    
    $
    (3,511,000
    )
    
    $
    (858,000
    )Basic loss per share
    
    $
    (0.34
    )
    
    $
    (0.08
    )Diluted loss per share
    
    $
    (0.34
    )
    
    $
    (0.08
    )Weighted shares outstanding:Basic
    
    
    10,180,000
    
    
    
    10,169,000Diluted
    
    
    10,180,000
    
    
    
    10,169,000




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##### Table of Contents



Common Shares
    
    
    AccumulatedShares
    
    
    Amount
    
    
    DeficitBalance as of March 31, 2007
    
    
    10,180,000
    
    
    
    13,526,000
    
    
    $
    (4,432,000
    )Stock-based compensation -
options
    
    
    
    
    
    
    8,000
    
    
    
    Warrants
    
    
    
    
    
    
    98,000Net loss
    
    
    
    
    
    
    
    
    
    
    (3,511,000
    )Balance at December 31, 2007
    
    
    10,180,000
    
    
    
    13,632,000
    
    
    $
    (7,943,000
    )




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##### Table of Contents



Nine Months EndedDecember 31,2007
    
    
    2006Cash flows from operating activities:Net loss
    
    $
    (3,511,000
    )
    
    $
    (858,000
    )Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:Depreciation and amortization of property and equipment
    
    
    225,000
    
    
    
    272,000Amortization of intangibles
    
    
    30,000
    
    
    
    32,000Loss on impairment of intangible assets
    
    
    48,000
    
    
    
    Amortization of deferred financing fees
    
    
    62,000
    
    
    
    Provision for losses on receivables
    
    
    (14,000
    )
    
    
    (9,000
    )Decrease (increase) in deferred income taxes
    
    
    
    
    
    
    (170,000
    )Stock-based compensation
    
    
    8,000
    
    
    
    67,000Warrant costs
    
    
    98,000
    
    
    
    Changes in assets and liabilities:Decrease (increase) in accounts receivable
    
    
    920,000
    
    
    
    990,000Decrease (increase) in inventories
    
    
    417,000
    
    
    
    (387,000
    )Decrease (increase) in income taxes refundable
    
    
    289,000
    
    
    
    83,000Decrease (increase) in prepaid expenses and other assets
    
    
    (286,000
    )
    
    
    (89,000
    )Increase (decrease) in accounts payable
    
    
    225,000
    
    
    
    617,000Increase (decrease) in accrued expenses
    
    
    (282,000
    )
    
    
    (175,000
    )Net cash (used in) provided by operating activities
    
    
    (1,771,000
    )
    
    
    373,000Cash flows from investing activities:Additions to intangible assets
    
    
    (42,000
    )
    
    
    (154,000
    )Capital expenditures
    
    
    (151,000
    )
    
    
    (73,000
    )Net cash (used in) provided by investing activities
    
    
    (193,000
    )
    
    
    (227,000
    )Cash flows from financing activities:Borrowings under revolving line of credit
    
    
    1,168,000
    
    
    
    Borrowings under long term debt
    
    
    750,000
    
    
    
    Payments on long term debt
    
    
    (68,000
    )
    
    
    (11,000
    )Net cash (used in) provided by financing activities
    
    
    1,850,000
    
    
    
    (11,000
    )Net increase (decrease) in cash
    
    
    (114,000
    )
    
    
    135,000Cash beginning of period
    
    
    375,000
    
    
    
    935,000Cash end of period
    
    $
    261,000
    
    
    $
    1,070,000Supplemental disclosure of cash flow information:Cash paid during the year for:Interest
    
    $
    211,000
    
    
    $
    




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##### Table of Contents



CHAD THERAPEUTICS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
 1.
    
    Basis of Presentation and Going ConcernCHAD 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 nine-month periods ended December 31, 2007, are not
necessarily indicative of the results expected for the year ended March 31, 2008. 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, 2007, Annual Report and particularly to Note 1 which
includes a summary of significant accounting policies.The Companys financial statements have been prepared and presented on a basis assuming it will
continue as a going concern. However, the Companys prospects must be considered in light of
substantial risks. The Company has experienced net losses since its fiscal year ended March 31,
2006 and as of December 31, 2007, it had an accumulated deficit of approximately $7,943,000.
For the nine months ended December 31, 2007, the Company had a net loss of $3,511,000 and
utilized approximately $1,771,000 of cash in operating activities. The Company expects
operating losses to continue through its foreseeable future. At the filing date, the Company
had utilized substantially all of the financing available through its revolving line of credit
and its term note. These factors, among others, indicate that the Company is in need of
additional financing or a strategic arrangement in order to continue operations. These factors
could raise doubts about the Companys ability to continue as a going concern.In order to address this situation, on November 16, 2007, the Company entered into a definitive
agreement, subject to shareholder approval, to sell to Inovo, Inc. (the Buyer) substantially
all of the assets of the Company related to the oxygen conserver business including accounts
receivable, inventory, and certain equipment and intellectual property (the Asset Sale)
pursuant to an Asset Purchase Agreement (the APA). Pursuant to the APA, the Buyer would
assume certain liabilities and obligations related to the Companys oxygen conserver business.
The Companys shareholders voted to approve the sale of the Companys oxygen conserver business
on January 31, 2008. The Asset Sale is scheduled to be completed on February 15, 2008. Once
the Asset Sale is completed, the Company will no longer develop and sell oxygen conserver
products. The Company will retain the assets related to its TOTAL O2 and in-home transfilling
business as well as products in development for the sleep disorder market. The Company is
currently seeking to sell its in-home trans-filling business. The Company intends to focus its
future efforts on the sleep disorder market.




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##### Table of Contents



The selling price for the conserver assets is $5,250,000, subject to adjustment for changes in
working capital between the execution date of the APA and closing date (the Selling Price).
The selling price may not exceed $5,500,000. There is no limit on a potential downward
adjustment of the selling price based on a reduction in the working capital as defined the APA.On January 2, 2008, CHAD Therapeutics Inc. (the Company) entered a Subordinated Secured Note
and Warrant Purchase Agreement (the Credit Facility) with Mr. Earl Yager and Mr. Thomas Jones,
our Chief Executive Officer and our Chairman of the Board, respectively. The Company entered
into the financing arrangement after it was unsuccessful in obtaining financing on acceptable
terms from a third party. The terms of the financing arrangement were negotiated and approved by
the Companys independent directors who concluded that the terms were more favorable to the
Company than those available from third party lenders. Pursuant to the terms of the Credit
Facility, the Company may draw an aggregate of $1,000,000, subject to certain conditions. As of
February 12, 2008, the Company had borrowed $550,000 under this facility.Notes issued under the Credit Facility bear interest at a rate of 8% per annum and will mature
at the earlier of (i) two business days after the closing of the APA with Inovo, or (ii) August
30, 2010. The notes are secured by a lien on the assets of the Company, which is subordinated to
the security interest of Calliope Capital Corporation discussed in Note 6 below.In connection with the Credit Facility, Mr. Yager and Mr. Jones received 321,428 warrants to
purchase our common stock at a price per share equal to $ .28 (the average closing price of our
common stock on the American Stock Exchange for the five days immediately preceding the initial
funding under the Credit Facility. The warrants have a term of five years. No additional
warrants are issuable in connection with any additional borrowings the Company may make under
the Credit Facility.If the Asset Sale to Inovo closes during the first calendar quarter of 2008, then the Company
anticipates it will have sufficient working capital in place for the next 12 months to continue
operations. If the Asset Sale is not completed during the first calendar quarter of 2008, then
the Company would require additional capital resources which may only be available pursuant to
terms and conditions that would result in significant cost to the Company and significant
dilution of the shareholders interest in the Company and its assets. Moreover, such additional
financing may not be available at all, in which event the Company would need to consider other
alternatives, including an orderly liquidation of its assets, curtailment of its current
operations and seeking protection under the federal bankruptcy laws. The financial statements
do not include any adjustments that might be required for the outcome of this uncertainty.2.
    
    Revenue RecognitionRevenue from product sales is recognized upon shipment of merchandise when title and risk of
loss transfers to the customer and the earnings process is complete. Products are shipped FOB
shipping point and title to the products transfers to the purchaser upon shipment. Under a
sales-type lease agreement, revenue is recognized at the time of the shipment with interest
income recognized over the life of the lease.




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##### Table of Contents



Shipping charges billed to customers are included in net sales. Allowances for customer
returns have not been established, as historically customer return experience has been minor.
Costs paid to shipping companies are recorded as a cost of sales.3.
    
    Major Customers
 Three Months Ended
    
    Nine Months EndedDecember 31,
    
    December 31,2007
    
    2006
    
    2007
    
    2006Customer A**
    
    
    32.6
    %
    
    
    43.9
    %
    
    
    39.1
    %
    
    
    39.7
    %
 
 **
    
    Indicates national chain customer The Companys customers are affected by Medicare reimbursement policy as approximately 80%
of home oxygen patients are covered by Medicare and other government programs.4.
    
    Concentration of Credit RiskAt times the Company maintains balances of cash that exceed $100,000 per financial institution,
the maximum insured by the Federal Deposit Insurance Corporation. Further, the Company
maintains a portion of its cash funds in an interest bearing, uninsured account. The Companys
right to the cash is subject to the risk that the financial institution will not pay when cash
is requested. The potential loss is the amount in any one financial institution over $100,000
and/or all funds in the interest bearing account. At December 31, 2007, the amount at risk was
approximately $261,000.The significant outstanding accounts receivable balances in 2007 were as follows:
 December 31
    
    March 31Customer A**
    
    
    24.8
    %
    
    
    41.0
    %Customer B**
    
    
    14.4
    %
    
    
    *
 
 *
    
    Indicates receivables balance less than 10% of the Companys net accounts receivable balance.**
    
    Indicates national chain customer. 5.
    
    InventoriesInventories in 2007 are summarized as follows:
 December 31
    
    
    March 31Finished goods
    
    $
    2,120,000
    
    
    $
    1,841,000Work-in-process
    
    
    1,837,000
    
    
    
    2,240,000Raw materials
    
    
    2,183,000
    
    
    
    2,476,000$
    6,140,000
    
    
    $
    6,557,000




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##### Table of Contents



6.
    
    Long-Term Debt and Revolving Line of CreditLong-term debt in 2007 consists of the following:
 December 31
    
    
    March 31Long-term note
    
    
    682,000
    
    
    
    Less current portion
    
    
    292,000
    
    
    
    Total long-term debt
    
    $
    390,000
    
    
    $
    
 In March 2007, the Company entered into a one-year factoring arrangement that provided for the
sale of up to $1,500,000 of the Companys accounts receivable. Assignments under the agreement
incurred interest at the banks prime rate plus two percent (2%) to three percent (3%)
depending on the total accounts receivable balance. The Company had a minimum monthly interest
payment of $6,000 beginning April 2007. The Company voluntarily terminated the factoring
agreement on July 30, 2007.On July 30, 2007, the Company entered into a financing transaction with Calliope Capital
Corporation , a Delaware corporation (the Investor) pursuant to which the Company issued to
the Investor a $750,000 convertible term note (Convertible Note) and a $2,750,000 revolving
credit line (Credit Line), all secured by the Companys assets. The Convertible Note is
payable in equal installments over 36 months beginning in November 2007 and maturing in July
2010 and bears interest at prime plus 2%, and the Credit Line bears interest at prime plus
1.5%. A portion of the financing was used to pay all outstanding obligations on the Companys
factoring arrangement. At the Investors option, the Convertible Note may be converted into
shares of the Companys common stock any time during the term of the note at a conversion price
of $1.18. The closing price of the Companys common stock on the issue date of the Convertible
Note was $1.00 per share. In addition, warrants to purchase up to 976,744 shares of the
Companys common stock were issued to the Investor with an exercise price of $1.24 per share.
The Investor was granted registration rights with respect to the shares underlying the
warrants. The warrants include a lock-up feature for a period of 12 months after any warrants
are exercised (see note 12.)On January 2, 2008, CHAD Therapeutics Inc. (the Company) entered a Subordinated Secured Note
and Warrant Purchase Agreement (the Credit Facility) with Mr. Earl Yager and Mr. Thomas
Jones, our Chief Executive Officer and our Chairman of the Board, respectively. The Company
entered into the financing arrangement after it was unsuccessful in obtaining financing on
acceptable terms from a third party. The terms of the financing arrangement were negotiated and
approved by the Companys independent directors who concluded that the terms were more
favorable to the Company than those available from third party lenders.




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Pursuant to the terms of the Credit Facility, the Company may draw an aggregate of $1,000,000,
subject to certain conditions. As of February 12, 2008, the Company had borrowed $550,000 under
this facility.Notes issued under the Credit Facility bear interest at a rate of 8% per annum and will mature
at the earlier of (i) two business days after the closing of the APA with Inovo, or (ii) August
30, 2010. The notes are secured by a lien on the assets of the Company, which is subordinated
to the security interest of Calliope Capital Corporation.In connection with the Credit Facility, Mr. Yager and Mr. Jones each received 321,428 warrants
to purchase our common stock at a price per share equal to $.28 (the average closing price of
our common stock on the American Stock Exchange for the five days immediately preceding the
initial funding under the Credit Facility). The number of shares issuable for each warrant
will be equal to (a) the principal amount of the Note issued at the Initial Closing multiplied
by 0.30, divided by (b) the Exercise Price. The warrants have a term of five years. No
additional warrants are issuable in connection with any additional borrowings the Company may
make under the Credit Facility.For the nine months ended December 31, 2007, amortization of deferred financing fees was
$62,000. There were no deferred financing fees in fiscal year 2006.
 7.
    
    Subsequent EventOn January 31, 2008, the Companys shareholders approved the sale of the Companys conserver
assets to Inovo pursuant to the APA and the sale is scheduled to close on February 15, 2008.Upon close of the Asset Sale, the Company will no longer obtain revenues from sales of CHAD
oxygen conserving devices. Such revenues were approximately 93% and 80% and 93% and 90% of the
Companys revenues for the three and nine-month periods ended December 31, 2007, and 2006,
respectively. The remaining revenues were derived from the sale of the Companys TOTAL O2 and
in-home transfilling products. The Company is currently seeking to sell such business. The
Company intends to focus its efforts on the development and commercialization of diagnostic and
therapeutic products for the sleep disorder market.8.
    
    Leasing ArrangementsIn the second quarter of fiscal year 2006, the Company entered into a capital lease agreement
for certain plant equipment totaling $14,000, with annual lease payments of $7,000, a fixed
interest rate of 7% and a purchase option at lease end in August 2007. The Company completed
the capital lease obligation in September 2007 and exercised the bargain purchase option at
that time. Amortization of plant equipment under capital leases is included in depreciation
expense.9.
    
    Loss Per Common ShareFollowing is a reconciliation of the numerators and denominators used in the calculation of
basic and diluted loss per common share:




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedDecember 31
    
    
    December 31,2007
    
    
    2006
    
    
    2007
    
    
    2006Basic loss per share:Numerator-net loss
    
    $
    (868,000
    )
    
    $
    (435,000
    )
    
    $
    (3,511,000
    )
    
    $
    (858,000
    )Denominator-weighted average
common shares outstanding
    
    
    10,180,000
    
    
    
    10,169,000
    
    
    
    10,180,000
    
    
    
    10,169,000Basic earnings loss per share
    
    $
    (0.09
    )
    
    $
    (0.04
    )
    
    $
    (0.34
    )
    
    $
    (0.08
    )Diluted loss per share:Numerator-net loss
    
    $
    (868,000
    )
    
    $
    (435,000
    )
    
    $
    (3,511,000
    )
    
    $
    (858,000
    )Denominator-weighted average
common shares outstanding
    
    
    10,180,000
    
    
    
    10,169,000
    
    
    
    10,180,000
    
    
    
    10,169,000Diluted
effect of common stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,180,000
    
    
    
    10,169,000
    
    
    
    10,180,000
    
    
    
    10,169,000Diluted earnings (loss) per share
    
    $
    (0.09
    )
    
    $
    (0.04
    )
    
    $
    (0.34
    )
    
    $
    (0.08
    )
 Options to purchase 872,000 shares of common stock at prices ranging from $0.50 to $7.62 per
share and 914,000 shares of common stock at prices ranging from $0.50 to $11.50 were not
included in the computation of diluted earnings per share for the three and nine-month periods
ended December 31, 2007 and 2006, respectively, because their effect would have been
anti-dilutive.10.
    
    Income Tax ExpenseBased on managements earnings projections for the fiscal year ended 2008, the Company has
forecasted an effective tax rate of 35 percent. As of March 31, 2007, the Company has Federal
net operating loss carryforwards of $1,459,000 expiring in 2027 and California net operating
loss carryforwards of $3,442,000 expiring in 2013 through 2017. In assessing the realizability
of deferred tax assets, management considered whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. At December 31, 2007, the
Companys deferred tax assets are fully offset by a valuation allowance.11.
    
    Geographic InformationThe Company has one reportable operating segment. Geographic information regarding the
Companys net sales is as follows:




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2007
    
    
    2006United States
    
    $
    2,495,000
    
    
    $
    3,774,000
    
    
    $
    8,652,000
    
    
    $
    11,916,000Canada
    
    
    46,000
    
    
    
    46,000
    
    
    
    114,000
    
    
    
    132,000Japan
    
    
    89,000
    
    
    
    73,000
    
    
    
    215,000
    
    
    
    267,000Europe
    
    
    185,000
    
    
    
    82,000
    
    
    
    651,000
    
    
    
    1,943,000Indonesia
    
    
    
    
    
    
    252,000
    
    
    
    175,000
    
    
    
    270,000All other countries
    
    
    114,000
    
    
    
    80,000
    
    
    
    301,000
    
    
    
    238,000$
    2,929,000
    
    
    $
    4,307,000
    
    
    $
    10,108,000
    
    
    $
    14,766,000
 All long-lived assets are located in the United States.Sales of OXYMATIC®, LOTUS and CYPRESS OXYPneumatic® conservers and SAGE Therapeutic devices
accounted for 64.4% and 64.9% of the Companys sales for the three-month periods ended December
31, 2007 and 2006, respectively and 66.3% and 69.6% of the Companys sales for the nine-month
periods ended December 31, 2007 and 2006 respectively.12.
    
    Stock Option PlanOn April 1, 2006, the Company adopted Statement of Financial Accounting Standards 123R,
Share-Based Payment, which revised SFAS 123, Accounting for Stock-Based Compensation. The
Company adopted FAS 123R using the modified prospective transition method. Previously, the
Company had followed APB 25, accounting for employee stock options at intrinsic value.
Accordingly, during the three and nine-month periods ended December 31, 2007 and 2006, the
Company recorded stock-based compensation expense for awards granted prior to, but not yet
vested, as of April 1, 2006, as if the fair value method required for pro forma disclosure under
FAS 123 were in effect for expense recognition purposes, adjusted for estimated forfeitures.
For stock-based awards granted after April 1, 2006, the Company would recognize compensation
expense based on the estimated grant date fair value method using the Black-Scholes valuation
model. For these awards, the Company would recognize compensation expense using a straight-line
method. As FAS 123R requires that stock based compensation expense be based on awards that are
ultimately expected to vest, stock-based compensation for the three and nine-month periods ended
December 31, 2007 and 2006, has been reduced for estimated forfeitures. For the nine-month
period ended December 31, 2007, stock-based compensation expense of $8,000 was recorded to
selling, general, and administrative expenses, all of which was due to FAS 123R option expense.
For the nine-month period ended December 31, 2006, stock-based compensation expense of $67,000
was recorded to selling, general, and administrative expenses. Of the $67,000 in stock-based
compensation recorded for the nine-month period ended December 31, 2006, $27,000 related to FAS
123R option expense with the remaining $40,000 related to restricted stock issued to directors
that vested April 1, 2006. Due to the prospective adoption of SFAS No. 123R, results for prior
period have not been restated.The Company has an equity incentive plan (the Plan) for key employees as defined under Section
422(A) of the Internal Revenue Code. The Plan provides that 750,000




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common shares be reserved
for issuance under the Plan, which expires on September 8, 2014, of which approximately 735,000
were available for future grant at December 31, 2007. In addition, the Plan provides that
non-qualified options can be granted to directors and independent contractors of the Company.
Stock options are granted with an exercise price equal to the market value of a share of the
Companys stock on the date of the grant. Historically, grants to non-employee directors have
vested over two
years, while the majority of grants to employees have vested over two to five years of
continuous service.The fair value of each stock option award is estimated on the date of the grant using the
Black-Scholes option valuation model. Expected volatility is based on the historical volatility
of the Companys stock. No expected dividend yield is used since the Company has not
historically declared or paid dividends and no dividends are expected in the foreseeable future.
The risk-free interest rate is based on the U.S. treasury yield curve on the grant date for the
expected term of the option. The Company did not grant any stock options during the nine months
ended December 31, 2007 and 2006, respectively. A summary of stock option activity as of and for
the nine-months ended December 31, 2007, is presented below:
 RemainingExercise
    
    
    ContractualPrice Per
    
    
    TermShares
    
    
    Share
    
    
    (in years)Outstanding at March 31, 2007
    
    
    904,000
    
    
    $
    2.09Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Forfeited or expired
    
    
    32,000
    
    
    
    1.52Outstanding at December 31, 2007
    
    
    872,000
    
    
    $
    2.04
    
    
    
    3.7As of December 31, 2007:Exercisable
    
    
    861,000
    
    
    $
    2.08
    
    
    
    3.7Vested and expected to vest
    
    
    869,000
    
    
    $
    2.09
    
    
    
    3.7
 No options were granted or exercised during the nine-months ended December 31, 2007 or 2006.The aggregate intrinsic value is calculated as the difference between the exercise price of the
underlying awards and the quoted price of the Companys common stock at December 31, 2007 for
the options that were in-the-money at December 31, 2007. As of December 31, 2007, there was
approximately $2,000 of unrecognized compensation cost related to unvested stock-based
compensation arrangements granted under the Plan. That cost is expected to be recognized over a
weighted-average period of 6 months.13.
    
    WarrantsIn connection with the Convertible Note financing transaction that the Company entered into in
July 2007, the Company issued warrants to purchase up to 976,744 shares of the Companys common
stock at an exercise price of $1.24 per share. The closing price of the Companys common stock
on the issue date of the warrants was




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$1.00 per share. The fair value of the warrants was
approximately $588,000 and was determined using a Black Scholes pricing model. These warrants
expire ten years from the date of issue and have a lock-up period of 12 months after any
warrants are exercised. The warrants will be amortized over the 36 month life of the
Convertible Note.For the nine months ended December 31, 2007, amortization of the warrants was $98,000. There
was no warrant amortization in fiscal year 2006.14.
    
    CommitmentsThe Company is currently leasing its administrative and plant facilities and certain office
equipment under noncancelable operating leases that expire in June 2008.The Company has minimum annual royalty requirements pursuant to the terms of license agreements
related to certain products in the amount of $530,000. License agreements with minimum annual
royalty requirements are in place through fiscal year 2016.Employee obligations consist of an employment agreement (the Employment Agreement) with
Thomas E. Jones, Chairman of the Board of Directors. The Employment Agreement does not have a
specific term and provides for a base salary of $160,000 per year, which is subject to annual
review by the Board of Directors. The Employment Agreement may be terminated at any time by
the Company, with or without cause, and may be terminated by Mr. Jones upon 90 days notice.
If Mr. Jones resigns or is terminated for cause (as defined in the Employment Agreement), he is
entitled to receive only his base salary and accrued vacation through the effective date of his
resignation or termination. If Mr. Jones is terminated without cause, he is entitled to
receive a severance benefit in accordance with the Companys Severance and Change of Control
Plan, or if not applicable, a severance benefit equal to 200% of his salary and incentive bonus
for the prior fiscal year. In estimating its contractual obligation, the Company has assumed
that Mr. Jones will voluntarily retire at the end of the year he turns 65 and that no severance
benefit will be payable. This date may not represent the actual date the Companys payment
obligations under the Employment Agreement are extinguished.From time to time, the Company becomes involved in certain legal actions in the ordinary
course of business. The Company is not currently party to any pending legal actions.15.
    
    Use of EstimatesThe 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, liabilities, revenues, and expenses, and the
disclosure of contingent assets and liabilities at the date of the financial statements.
Actual results may differ from those estimates.




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16.
    
    Accounting StandardsIn February 2007, the FASB issued SFAS No. 159, The Fair Value Option of Financial Assets and
Financial Liabilities. SFAS No. 159 permits companies to choose to measure certain financial
instruments and certain other items at fair value. The standard requires that unrealized gains
and losses on items for which the fair value option has been elected by reported in earnings.
SFAS No. 159 is effective as of the beginning of the entitys first fiscal year that begins
after November 15, 2007. The Company is currently evaluating the impact that SFAS No. 159 will
have on its financial statements.
        .




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TABLE OF CONTENTS  Item 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3. Quantitative and Qualitative Disclosures about Market RisksItem 4. Controls and ProceduresPart IIItem 1. Legal ProceedingsItem 2. Unregistered Sales of Equity Securities and Use of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. Submission of Matters to a Vote of Security HoldersItem 5. Other InformationItem 6. ExhibitsSIGNATUREINDEX TO EXHIBITSEXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32EXHIBIT 99.1    Table of Contents




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®




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Payments Due by PeriodContractual
    
    
    
    
    
    Less than 1
    
    1  3
    
    3  5
    
    After 5Obligations
    
    Total
    
    Year
    
    Years
    
    Years
    
    YearsOperating lease
obligations
    
    $
    246,000
    
    
    $
    237,000
    
    
    $
    9,000
    
    
    
    
    
    
    
    Minimum
royalty obligations
    
    $
    1,627,000
    
    
    $
    530,000
    
    
    $
    1,007,000
    
    
    $
    90,000
    
    
    
    Employee obligations
    
    $
    160,000
    
    
    $
    160,000
    
    
    
    
    
    
    
    
    
    
    
    Convertible Note
    
    $
    682,000
    
    
    $
    250,000
    
    
    $
    250,000
    
    
    $
    182,000
    
    
    
    




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(a)
    
    The Companys Special Meeting of Shareholders was held on January 31, 2008
in Chatsworth, California.(b)
    
    Proxies for the meeting were solicited pursuant to Regulation 14A under the
Securities Exchange Act of 1934..(c)
    
    At the Special Meeting, the following matters were considered and voted upon:
 (i)
    
    The approval of the sale of the Companys oxygen conserver
business in accordance with the terms and conditions of an Asset Purchase
Agreement, dated as of November 16, 2007, between Inovo, Inc., a Florida
corporation, and CHAD Therapeutics, Inc., a California corporation
 For
    
    Against
    
    WithheldTo approve the Asset Sale
    
    
    7,183,378
    
    
    
    49,300
    
    
    
    8,807
 
   
  (1)
 (2)
 
 (1)
    
    Previously filed as an Exhibit to the Registrants Registration
Statement on Form S-18, File No. 2-83926.(2)
    
    Previously filed as an Exhibit to the Registrants Annual Report on Form
10-K for the year ended March 31, 1986.(3)
    
    Previously filed as an Exhibit to the Registrants Annual Report on Form
10-K for the year ended March 31, 1993.(4)
    
    Previously filed as an exhibit to the Registrants Annual Report on Form
10-K for the year ended March 31, 1996.(5)
    
    Previously filed as an exhibit to the Registrants Annual Report on Form
10-K for the year ended March 31, 1998.(6)
    
    Previously filed as Appendix A of the Registrants Proxy Statement for the
2004 Annual Shareholders Meeting.(7)
    
    Previously filed as an Exhibit to the Registrants Form 8-K dated August 3,
2007.(8)
    
    Previously filed as an Exhibit to the Registrants Report on Form 10-Q for
the quarter ended September 30, 2007.




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(3)
 (4)
 (4)
 (5)
 (6)
 (7)
 (7)
 (7)
 (7)
 (7)
 (8)
     
 *
    
    The information in Exhibit 32 shall not be deemed filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the
liabilities of that section, nor shall they be deemed incorporated by reference in any filing under
the Securities Act of 1933, as amended, or the Exchange Act (including this quarterly report),
unless CHAD Therapeutics specifically incorporates the foregoing information into those documents
by reference.




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CHAD THERAPEUTICS, Inc.(Registrant)Date 02/14/2008
    
    /s/ Earl L. YagerEarl L. YagerPresident and Chief Executive OfficerDate 02/14/2008
    
    /s/ Tracy A. Kern

Tracy A. KernChief Financial Officer




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Exhibit No.
    
    Description of Exhibits31.1
    
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CEO31.2
    
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CFO32*
    
    Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 200299.1
    
    Press release dated February 14, 2008
 
 *
    
    The information in Exhibit 32 shall not be deemed filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the
liabilities of that section, nor shall they be deemed incorporated by reference in any filing under
the Securities Act of 1933, as amended, or the Exchange Act (including this quarterly report),
unless CHAD Therapeutics specifically incorporates the foregoing information into those documents
by reference.