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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934 þ
For Quarterly Period Ended: December 31, 2004 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.)
 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. 
Yes þ No o Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act.)
Yes o Noþ As of December 31, 2004, the registrant had 10,126,000 shares of its common stock outstanding.




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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. Changes in 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. ExhibitsSIGNATUREINDEX TO EXHIBITSExhibit 31.1Exhibit 31.2Exhibit 32    Table of Contents  CHAD THERAPEUTICS, INC.
Condensed Balance Sheets
December 31, 2004 and March 31, 2004
(Unaudited) December 31,
    
    
    March 31,2004
    
    
    2004ASSETSCurrent Assets:Cash
    
    $
    2,021,000
    
    
    $
    2,708,000Accounts receivable, less allowance for
doubtful accounts of $68,000 at
December 31, 2004 and $68,000 at
March 31, 2004
    
    
    3,628,000
    
    
    
    2,911,000Inventories, net (Note 2)
    
    
    7,357,000
    
    
    
    4,989,000Prepaid expenses
    
    
    349,000
    
    
    
    233,000Deferred income taxes
    
    
    691,000
    
    
    
    224,000Total current assets
    
    
    14,046,000
    
    
    
    11,065,000Property and equipment, at cost
    
    
    5,985,000
    
    
    
    5,789,000Less accumulated depreciation
    
    
    4,845,000
    
    
    
    4,571,000Net property and equipment
    
    
    1,140,000
    
    
    
    1,218,000Intangible assets, net
    
    
    700,000
    
    
    
    729,000Other assets, net
    
    
    87,000
    
    
    
    31,000Total assets
    
    $
    15,973,000
    
    
    $
    13,043,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,839,000
    
    
    $
    502,000Accrued expenses
    
    
    1,290,000
    
    
    
    1,185,000Income taxes payable
    
    
    418,000
    
    
    
    203,000Total current liabilities
    
    
    3,547,000
    
    
    
    1,890,000Shareholders equity:Common shares, $.01 par value, authorized
40,000,000 shares; 10,126,000 and 10,096,000
shares issued and outstanding
    
    
    13,360,000
    
    
    
    13,309,000Accumulated deficit
    
    
    (934,000
    )
    
    
    (2,156,000
    )Total shareholders equity
    
    
    12,426,000
    
    
    
    11,153,000Total liabilities and shareholders equity
    
    $
    15,973,000
    
    
    $
    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 December 31, 2004 and 2003
(Unaudited) Three Months EndedDecember 31,2004
    
    
    2003Net sales
    
    $
    6,444,000
    
    
    $
    5,237,000Cost of sales
    
    
    3,741,000
    
    
    
    3,017,000Gross profit
    
    
    2,703,000
    
    
    
    2,220,000Costs and expenses:Selling, general and administrative
    
    
    1,858,000
    
    
    
    1,460,000Research and development
    
    
    380,000
    
    
    
    343,000Total costs and expenses
    
    
    2,238,000
    
    
    
    1,803,000Operating income
    
    
    465,000
    
    
    
    417,000Other income
    
    
    14,000
    
    
    
    20,000Earnings before income taxes
    
    
    479,000
    
    
    
    437,000Income tax expense (benefit)
    
    
    (26,000
    )
    
    
    19,000Net earnings
    
    $
    505,000
    
    
    $
    418,000Basic earnings per share
    
    $
    0.05
    
    
    $
    0.04Diluted earnings per share
    
    $
    0.05
    
    
    $
    0.04Weighted shares outstanding:Basic
    
    
    10,124,000
    
    
    
    10,088,000Diluted
    
    
    10,647,000
    
    
    
    10,401,000
 See accompanying notes to condensed financial statements.




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CHAD THERAPEUTICS, INC.
Condensed Statements of Operations
For the six months ended December 31, 2004 and 2003
(Unaudited) Nine Months EndedDecember 31,2004
    
    
    2003Net sales
    
    $
    18,852,000
    
    
    $
    16,190,000Cost of sales
    
    
    11,116,000
    
    
    
    9,608,000Gross profit
    
    
    7,736,000
    
    
    
    6,582,000Costs and expenses:Selling, general and administrative
    
    
    5,306,000
    
    
    
    4,771,000Research and development
    
    
    1,207,000
    
    
    
    1,011,000Total costs and expenses
    
    
    6,513,000
    
    
    
    5,782,000Operating income
    
    
    1,223,000
    
    
    
    800,000Other income  interest income, net
    
    
    28,000
    
    
    
    29,000Earnings before income taxes
    
    
    1,251,000
    
    
    
    829,000Income tax expense
    
    
    29,000
    
    
    
    37,000Net earnings
    
    $
    1,222,000
    
    
    $
    792,000Basic earnings per share
    
    $
    0.12
    
    
    $
    0.08Diluted earnings per share
    
    $
    0.12
    
    
    $
    0.08Weighted shares outstanding:Basic
    
    
    10,119,000
    
    
    
    10,080,000Diluted
    
    
    10,622,000
    
    
    
    10,331,000
 See accompanying notes to the condensed financial statements.




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CHAD THERAPEUTICS, INC.
Condensed Statement of Shareholders Equity
For the nine months ended December 31, 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
    
    
    30,000
    
    
    
    51,000
    
    
    
    Net earnings
    
    
    
    
    
    
    
    
    
    
    1,222,000Balance at December 31, 2004
    
    
    10,126,000
    
    
    $
    13,360,000
    
    
    $
    (934,000
    )
 See accompanying notes to consolidated financial statements.




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CHAD THERAPEUTICS, INC.
Condensed Statements of Cash Flows
For the nine months ended December 31, 2004 and 2003
(Unaudited) Nine Months EndedDecember 31,2004
    
    
    2003Cash flows from operating activities:Net earnings
    
    $
    1,222,000
    
    
    $
    792,000Adjustments to reconcile net earnings to net cash
provided by (used in) operating activities:Depreciation and amortization of property and
equipment
    
    
    274,000
    
    
    
    349,000Amortization of intangibles
    
    
    29,000
    
    
    
    1,000Changes in assets and liabilities:Decrease (increase) in accounts receivable
    
    
    (717,000
    )
    
    
    (487,000
    )Decrease (increase) in inventories
    
    
    (2,368,000
    )
    
    
    (202,000
    )Decrease (increase) in prepaid expenses
    
    
    (116,000
    )
    
    
    224,000Decrease (increase) in other assets
    
    
    (56,000
    )
    
    
    (12,000
    )Decrease (increase) in deferred income tax
    
    
    (467,000
    )
    
    
    Increase (decrease) in accounts payable
    
    
    1,337,000
    
    
    
    (388,000
    )Increase (decrease) in accrued expenses
    
    
    105,000
    
    
    
    (257,000
    )Increase (decrease) in income taxes payable
    
    
    215,000
    
    
    
    34,000Net cash provided by (used in) operating activities
    
    
    (542,000
    )
    
    
    54,000Cash flows from investing activities:Additions to other assets
    
    
    
    
    
    
    (63,000
    )Capital expenditures
    
    
    (196,000
    )
    
    
    (235,000
    )Net cash used in investing activities
    
    
    (196,000
    )
    
    
    (298,000
    )Cash flows from financing activities:Exercise of stock options
    
    
    51,000
    
    
    
    22,000Net cash provided by financing activities
    
    
    51,000
    
    
    
    22,000Net decrease in cash
    
    
    (687,000
    )
    
    
    (222,000
    )Cash beginning of period
    
    
    2,708,000
    
    
    
    1,596,000Cash end of period
    
    $
    2,021,000
    
    
    $
    1,374,000
 See accompanying notes to condensed financial statements.




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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 and nine month periods ended December 31, 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.
    ReclassificationsCertain reclassifications have been made to the prior years balances to conform to the
presentation for the three and nine months ended December 31, 2004.3.
    InventoriesInventories in 2004 are summarized as follows: December 31
    
    
    March 31Finished goods
    
    $
    2,217,000
    
    
    $
    1,223,000Work-in-process
    
    
    1,684,000
    
    
    
    1,062,000Raw materials
    
    
    3,456,000
    
    
    
    2,704,000$
    7,357,000
    
    
    $
    4,989,000




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4.
    Earnings Per Common Share  Following is a reconciliation of the numerators and denominators used in the calculation of
basic and diluted earnings per common share: Three Months Ended December 31,
    
    
    Nine Months Ended December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Basic earnings per share:Numerator-net earnings
    
    $
    505,000
    
    
    $
    418,000
    
    
    $
    1,222,000
    
    
    $
    792,000Denominator-weighted average
common shares outstanding
    
    
    10,124,000
    
    
    
    10,088,000
    
    
    
    10,119,000
    
    
    
    10,080,000Basic earnings per share
    
    $
    0.05
    
    
    $
    0.04
    
    
    $
    0.12
    
    
    $
    0.08Diluted earnings per share:Numerator-net earnings
    
    $
    505,000
    
    
    $
    418,000
    
    
    $
    1,222,000
    
    
    $
    792,000Denominator:Weighted average common shares
outstanding
    
    
    10,124,000
    
    
    
    10,088,000
    
    
    
    10,119,000
    
    
    
    10,080,000Diluted effect of common stock options
    
    
    523,000
    
    
    
    313,000
    
    
    
    503,000
    
    
    
    251,00010,647,000
    
    
    
    10,401,000
    
    
    
    10,622,000
    
    
    
    10,331,000Diluted earnings per share
    
    $
    0.05
    
    
    $
    0.04
    
    
    $
    0.12
    
    
    $
    0.08
  Options to purchase 225,000 shares of common stock at prices ranging from $5.00 to $12.54 per
share and 395,000 shares of common stock at prices ranging from $2.39 to $13.47 were not
included in the computation of diluted earnings per share for the three and nine month periods
ended December 31, 2004 and 2003, respectively, because their effect would have been
anti-dilutive.5.
    Income Tax ExpenseAt December 31, 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 $1,535,000, against which a full valuation allowance has been recorded.
California suspended the utilization of net operating loss carryforwards during tax years
starting in 2002 and 2003. As a result, the Company has been unable to use its California net
operating loss carryforwards until the tax year that began April 1, 2004. The California net
operating losses expire in 2006.




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6.
    Geographic InformationThe Company has one reportable operating segment. Geographic information regarding the
Companys sales is as follows: Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003United States
    
    $
    6,115,000
    
    
    $
    4,977,000
    
    
    $
    17,768,000
    
    
    $
    15,471,000Canada
    
    
    82,000
    
    
    
    67,000
    
    
    
    238,000
    
    
    
    213,000Germany
    
    
    4,000
    
    
    
    7,000
    
    
    
    9,000
    
    
    
    52,000Japan
    
    
    127,000
    
    
    
    123,000
    
    
    
    330,000
    
    
    
    178,000All other countries
    
    
    116,000
    
    
    
    63,000
    
    
    
    507,000
    
    
    
    276,000$
    6,444,000
    
    
    $
    5,237,000
    
    
    $
    18,852,000
    
    
    $
    16,190,000
  All long-lived assets are located in the United States.Sales of OXYMATIC® and CYPRESS OXYPneumatic® conservers accounted for 67% and 78% of the
Companys sales for the three month periods ended December 31, 2004 and 2003, and 74% and 67%
for the nine month periods ended December 31, 2004 and 2003, respectively.7.
    Major CustomersFour major national chains accounted for 54% and 49% of the Companys net sales for the nine
month periods ended December 31, 2004 and 2003, respectively. One chain accounted for 34% and
26% of sales for the nine month periods ended December 31, 2004 and 2003, respectively, and
one other chain accounted for 13% and 15% of sales for the nine month periods ended December
31, 2004 and 2003, respectively.8.
    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.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:




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Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2004
    
    
    2003Net earnings, as reported
    
    $
    505,000
    
    
    $
    418,000
    
    
    $
    1,222,000
    
    
    $
    792,000Deduct: Total stock based employee
compensation expense determined under
fair value-based method for all awards, net
of related tax effects
    
    
    27,000
    
    
    
    18,000
    
    
    
    82,000
    
    
    
    77,000Pro forma net income
    
    $
    478,000
    
    
    $
    400,000
    
    
    $
    1,140,000
    
    
    $
    715,000Earnings per share:Basic  as reported
    
    $
    0.05
    
    
    $
    0.04
    
    
    $
    0.12
    
    
    $
    0.08Basic  pro forma
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.11
    
    
    
    0.07Diluted  as reported
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.12
    
    
    
    0.08Diluted  proforma
    
    
    0.04
    
    
    
    0.04
    
    
    
    0.11
    
    
    
    0.07




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations 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 54% and 49% of the Companys net sales, for the nine month periods
ended December 31, 2004 and 2003, respectively. One chain accounted for 34% and 26% of sales for
the nine month periods ended December 31, 2004 and 2003, respectively, and one other chain
accounted for 13% and 15% of sales for the nine month periods ended December 31, 2004 and 2003,
respectively. This increased dependence on a limited number of large customers may result in
greater volatility and unpredictability of future operating results as changes in the purchasing
decisions by one or more major customers can have a material affect upon our financial statements. 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




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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 began shipping in December 2001, and the Company began shipment of
the CYPRESS OXYPneumatic conserver in July 2002. The Company received clearance from the FDA to
market its newest oxygen conserving device, the LOTUS Electronic Oxygen Conserver, in October 2004
with plans to begin shipment of the new device in February 2005. The LOTUS Electronic Oxygen
Conserver weighs less than a pound and will be offered with or without a breath-sensing alarm. It
will also offer additional liter flow settings and an extended battery life of up to four months of
normal usage on two AA-size batteries. 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 began selling the SAGE nationwide in October 2004.
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




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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:  
    Development of additional oxygen conserver models, such as the
LOTUS Electronic Oxygen Conserver introduced in October 2004, that
diversify the product line in order to offer customers a 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 should 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 Net sales for the three and nine month periods ended December 31, 2004 increased by $1,209,000
(23.1%) and $2,662,000 (16.4%) respectively, as compared to the same periods in the prior year.
The primary driver of the Companys increase in sales has been the significant growth in sales of
its conservers and therapeutic devices. Management believes that the performance features of its
conservers and therapeutic devices have enabled the Company to recapture significant market share.
Domestic unit sales of conservers and therapeutic devices for the three and nine month periods
ended December 31, 2004, increased 30% and 41%, respectively over the prior year, while the
increase in domestic revenues from conserver sales was 6% and 9%, respectively. 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. As noted above, management expects
continued downward pressure on its average selling price.




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Sales of the SAGE Oxygen Therapeutic Device are increasing. A customer that placed a large order
for SAGE devices earlier in the year is taking delivery of the devices at a slower rate than was
originally planned. The Company is working with the customer on a revised delivery schedule that
will likely stretch into fiscal 2006. In addition, during the three month period ended December
31, 2004, the Company experienced a decline in sales of the OXYMATIC 400 series as a result of
reduced orders from a large customer. The Company is pursuing efforts to reverse the decline in
orders from this customer. However, at this time it is not clear if the Companys efforts will be
successful or if it will experience a continued decline in sales of the OXYMATIC 400 device to
this customer. Future operating results may be increasingly dependent upon purchase decisions of a
limited number of large customers. The Company saw significant growth in sales of its TotalO2 Delivery System during the quarter ended
December 31, 2004. Upcoming changes in Medicare reimbursement have increased interest in the
TotalO2 System as a cost effective way to fulfill home care provider and patient needs. Revenues
from TotalO2 sales increased 281% and 97%, respectively, for the three and nine month periods ended
December 31, 2004, as compared to the prior years periods. Sales to foreign distributors represented 5.2% and 5.0% of total sales for the three month periods
ended December 31, 2004 and 2003, respectively, and 5.9% and 4.6% for the nine month periods ended
December 31, 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 57.6% to 58.0% for the three month period
ended December 31, 2004 and decreased from 59.4% to 59.0% for the nine month period ended December
31, 2004, as compared to the same periods in the prior year. The increase in cost of sales as a
percentage of sales for the three month period ended December 31, 2004 as compared to the same
period in the prior year is due to a shift in product mix in the third quarter, while the decrease
for the nine month period was a result of overhead efficiencies achieved due to production
increases related to the increase in sales. Selling, general and administrative expenditures increased from 27.7% to 28.8% and decreased from
29.5% to 28.2% of net sales for the three and nine month periods ended December 31, 2004,
respectively, as compared to the same periods 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
$36,000 for the three month period ended December 31, 2004 and $196,000 for the nine month period
ended December 31, 2004 , as compared to the same periods in 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. During fiscal
year 2004, the Company spent $1,292,000 on research and development.




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On July 31, 2002, a national chain accounting for less than 10% of sales in fiscal 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 approved the Plan.
Payments to the unsecured creditors commenced on July 1, 2003. As of December 31, 2004, this debt
to the Company had been reduced to approximately $48,000, and in January 2005 the Company received
payment of $43,000 against the remaining balance. At December 31, 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 $1,535,000, against which a partial 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 has been unable to use its California net
operating loss carryforwards until the tax year which began April 1, 2004. The California net
operating losses expire in 2006. Financial Condition
At December 31, 2004, the Company had cash totaling $2,021,000 or 12.7% 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 $10,499,000 at December 31, 2004. Net accounts receivable
increased $717,000 during the nine months ended December 31, 2004, due to the increase in sales
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 $2,368,000, in significant part as a result of the Companys efforts to fill a large
purchase order for SAGE devices. Delivery of units pursuant to that purchase order have been
stretched out beyond the originally contemplated timetable. 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 plan for
anticipated orders and 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 should be adequate to meet the
Companys near and long term cash requirements given the Companys recent operating performance.
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. Historically, the
Company has financed its inventory requirements out of cash flow and it has not sought to finance
its accounts receivable. It is possible the Company might seek financing arrangements for working
capital in the future. 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.




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The following table aggregates all of the Companys material contractual obligations as of December
31, 2004: Payments Due by PeriodContractual
    
    
    
    
    
    Less than 1
    
    
    1  3
    
    
    3-5
    
    
    After 5Cash Obligations
    
    Total
    
    
    Year
    
    
    Years
    
    
    Years
    
    
    YearsOperating lease
obligations
    
    $
    1,412,000
    
    
    $
    418,000
    
    
    $
    994,000
    
    
    
    
    
    
    
    
 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 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




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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, CYPRESS OXYPneumatic, and LOTUS 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. 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. Failure to meet customer
demand on a timely basis could result in lost orders or could harm the Companys reputation.




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##### Table of Contents



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 54% of the Companys net sales during the year ended March 31, 2004 and for
49% of net sales for the nine months ended December 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 and which may result in greater volatility and less predictability of the
Companys operating results. Moreover, the loss of a major customer or a significant decline in
orders from a major customer could have a material adverse effect upon the Companys revenues and
profitability.. 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 proposals to regulate, control or alter the method of financing health care costs have
been discussed and certain such bills have been introduced in Congress, and various state
legislatures. Because of the uncertain state and widely varying terms 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. 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.




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##### Table of Contents



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 November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standard (SFAS) No 151 (Inventory Costs), an amendment of ARB No. 43, Chapter 4. The statement
clarifies accounting for abnormal amounts of idle facility expense, freight, handling costs and
spoilage and requires those items to be expensed when incurred. SFAS 151 is applicable to
inventory costs incurred during fiscal years beginning after June 15, 2005. The Company has not
yet determined if the adoption of this standard will have a significant impact on its financial
statements. In December 2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 123R (Share-Based Payment). SFAS 123R requires the Company to
recognize compensation expense based on the fair value of equity instruments awarded to employees.
We will adopt SFAS 123R on July 1, 2005, and the Company does not anticipate a significant impact
to its financial statements.




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##### Table of Contents



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 about 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 December 31, 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). 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 to ensure that we record, process, summarize, and report information required to be
disclosed by us in our quarterly reports filed under Securities Exchange Act within the time
periods specified by the Securities and Exchange Commissions rules and forms. 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 1. Legal Proceedings None. 
 Item 2. Changes in 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 None 
 Item 5. Other Information None.




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##### Table of Contents



Item 6. Exhibits  (a) 31.1
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CEO  (b) 31.2
    Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002 for CFO  (c) 32*
    Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of
Sarbanes-Oxley Act of 2002 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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##### Table of Contents



SIGNATURE 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 02/10/2005
    
    /s/ Earl L. YagerEarl L. YagerPresident and Chief Executive OfficerDate 02/10/2005
    
    /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 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 2002
 *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.
Certification pursuant to 18 U.S.C Section 1350