##### Table of Contents



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 1934
 For Quarterly Period Ended: September 30, 2006
 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
  o o þ
  o þ




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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 1A. Risk FactorsItem 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  
 September 30,
    
    
    March 31,2006
    
    
    2006ASSETSCurrent assets:Cash
    
    $
    1,777,000
    
    
    $
    935,000Accounts receivable, less allowance for
doubtful accounts of $54,000 at
September 30, 2006, and $52,000 at
March 31, 2006
    
    
    2,568,000
    
    
    
    3,220,000Income taxes refundable
    
    
    182,000
    
    
    
    383,000Inventories (Note 5)
    
    
    6,303,000
    
    
    
    6,381,000Prepaid expenses and other assets
    
    
    146,000
    
    
    
    178,000Deferred income taxes
    
    
    640,000
    
    
    
    666,000Total current assets
    
    
    11,616,000
    
    
    
    11,763,000Property and equipment, at cost
    
    
    6,163,000
    
    
    
    6,101,000Less accumulated depreciation
    
    
    5,345,000
    
    
    
    5,151,000Net property and equipment
    
    
    818,000
    
    
    
    950,000Intangible assets, net
    
    
    1,073,000
    
    
    
    972,000Deferred income taxes
    
    
    610,000
    
    
    
    600,000Other assets
    
    
    44,000
    
    
    
    71,000Total assets
    
    $
    14,161,000
    
    
    $
    14,356,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    923,000
    
    
    $
    522,000Accrued expenses
    
    
    1,206,000
    
    
    
    1,435,000Total current liabilities
    
    
    2,129,000
    
    
    
    1,957,000Other long-term liabilities
    
    
    
    
    
    
    4,000Total liabilities
    
    
    2,129,000
    
    
    
    1,961,000Shareholders equity:Common shares, $.01 par value, authorized
40,000,000 shares; 10,169,000 and 10,158,000
shares issued and outstanding
    
    
    13,473,000
    
    
    
    13,413,000Accumulated deficit
    
    
    (1,441,000
    )
    
    
    (1,018,000
    )Total shareholders equity
    
    
    12,032,000
    
    
    
    12,395,000Total liabilities and shareholders equity
    
    $
    14,161,000
    
    
    $
    14,356,000




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##### Table of Contents



Three Months EndedSeptember 30,2006
    
    
    2005Net sales
    
    $
    4,983,000
    
    
    $
    5,375,000Cost of sales
    
    
    3,366,000
    
    
    
    3,594,000Gross profit
    
    
    1,617,000
    
    
    
    1,781,000Costs and expenses:Selling, general, and administrative
    
    
    1,682,000
    
    
    
    1,699,000Research and development
    
    
    322,000
    
    
    
    435,000Total costs and expenses
    
    
    2,004,000
    
    
    
    2,134,000Operating loss
    
    
    (387,000
    )
    
    
    (353,000
    )Other income
    
    
    16,000
    
    
    
    13,000Loss before income taxes
    
    
    (371,000
    )
    
    
    (340,000
    )Income tax benefit
    
    
    (64,000
    )
    
    
    (130,000
    )Net loss
    
    $
    (307,000
    )
    
    $
    (210,000
    )Basic loss per share
    
    $
    (0.03
    )
    
    $
    (0.02
    )Diluted loss per share
    
    $
    (0.03
    )
    
    $
    (0.02
    )Weighted shares outstanding:Basic
    
    
    10,169,000
    
    
    
    10,141,000Diluted
    
    
    10,169,000
    
    
    
    10,141,000




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Six Months EndedSeptember 30,2006
    
    
    2005Net sales
    
    $
    10,459,000
    
    
    $
    11,270,000Cost of sales
    
    
    7,028,000
    
    
    
    7,388,000Gross profit
    
    
    3,431,000
    
    
    
    3,882,000Costs and expenses:Selling, general, and administrative
    
    
    3,384,000
    
    
    
    3,543,000Research and development
    
    
    657,000
    
    
    
    767,000Total costs and expenses
    
    
    4,041,000
    
    
    
    4,310,000Operating loss
    
    
    (610,000
    )
    
    
    (428,000
    )Other income
    
    
    39,000
    
    
    
    19,000Loss before income taxes
    
    
    (571,000
    )
    
    
    (409,000
    )Income tax benefit
    
    
    (148,000
    )
    
    
    (157,000
    )Net loss
    
    $
    (423,000
    )
    
    $
    (252,000
    )Basic loss per share
    
    $
    (0.04
    )
    
    $
    (0.02
    )Diluted loss per share
    
    $
    (0.04
    )
    
    $
    (0.02
    )Weighted shares outstanding:Basic
    
    
    10,169,000
    
    
    
    10,137,000Diluted
    
    
    10,169,000
    
    
    
    10,137,000







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Common Shares
    
    
    AccumulatedShares
    
    
    Amount
    
    
    DeficitBalance as of March 31, 2006
    
    
    10,158,000
    
    
    $
    13,413,000
    
    
    $
    (1,018,000
    )Stock-based compensation  options
    
    
    
    
    
    
    20,000
    
    
    
    Stock-based
compensation - restricted stock
    
    
    11,000
    
    
    
    40,000
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    (423,000
    )Balance at September 30, 2006
    
    
    10,169,000
    
    
    
    13,473,000
    
    
    $
    (1,441,000
    )







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Six Months EndedSeptember 30,2006
    
    
    2005Cash flows from operating activities:Net loss
    
    $
    (423,000
    )
    
    $
    (252,000
    )Adjustments to reconcile net loss to net cash
provided by operating activities:Depreciation and amortization of property and equipment
    
    
    194,000
    
    
    
    214,000Amortization of intangibles
    
    
    21,000
    
    
    
    20,000Provision for losses on receivables
    
    
    20,000
    
    
    
    21,000Decrease (increase) in deferred income taxes
    
    
    16,000
    
    
    
    Stock-based compensation
    
    
    60,000
    
    
    
    Changes in assets and liabilities:Decrease (increase) in accounts receivable
    
    
    632,000
    
    
    
    711,000Decrease (increase) in inventories
    
    
    78,000
    
    
    
    394,000Decrease (increase) in income taxes refundable
    
    
    201,000
    
    
    
    (203,000
    )Decrease (increase) in prepaid expenses and other assets
    
    
    59,000
    
    
    
    (57,000
    )Increase (decrease) in accounts payable
    
    
    401,000
    
    
    
    7,000Increase (decrease) in accrued expenses
    
    
    (229,000
    )
    
    
    (194,000
    )Increase (decrease) in income taxes payable
    
    
    
    
    
    
    (200,000
    )Net cash
provided by operating activities
    
    
    1,030,000
    
    
    
    461,000Cash flows from investing activities:Additions to intangible assets
    
    
    (122,000
    )
    
    
    (81,000
    )Capital expenditures
    
    
    (62,000
    )
    
    
    (133,000
    )Net cash used in investing activities
    
    
    (184,000
    )
    
    
    (214,000
    )Cash flows from financing activities:Other long-term liabilities
    
    
    (4,000
    )
    
    
    10,000Net cash
(used in) provided by financing activities
    
    
    (4,000
    )
    
    
    10,000Net increase in cash
    
    
    842,000
    
    
    
    257,000Cash beginning of period
    
    
    935,000
    
    
    
    177,000Cash end of period
    
    $
    1,777,000
    
    
    $
    434,000Supplemental disclosure of cash flow information:Acquisition of capital assets through capital lease
    
    $
    
    
    
    $
    14,000




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CHAD THERAPEUTICS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
 1.
    
    Interim ReportingCHAD Therapeutics, Inc. (the Company) is in the business of developing, producing, and
marketing respiratory care devices designed to improve the efficiency of oxygen delivery systems
for home health care and hospital treatment of patients suffering from pulmonary diseases.In the opinion of management, all adjustments necessary, which are of a normal and recurring
nature, for a fair presentation of the results for the interim periods presented, have been
made. The results for the six-month period ended September 30, 2006, are not necessarily
indicative of the results expected for the year ended March 31, 2007. 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, 2006, Annual Report and particularly to Note 1 which includes
a summary of significant accounting policies.2.
    
    Revenue RecognitionThe Company recognizes revenue when title and risk of loss transfers to the customer and the
earnings process is complete. Under a sales-type lease agreement, revenue is recognized at the
time of shipment with interest income recognized over the life of the lease. The Company
records all shipping fees billed to customers as revenue, and related costs as costs of good
sold, when incurred.3.
    
    Major Customers
 Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Customer A**
    
    
    39.5
    %
    
    
    38.8
    %
    
    
    38.0
    %
    
    
    37.6
    %Customer B
    
    
    10.5
    %
    
    
    10.0
    %
    
    
    11.7
    %
    
    
    *
 
 *
    
    Indicates sales less than 10% of the Companys net sales**
    
    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 account, the maximum
insured by the Federal Deposit Insurance Corporation. 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 account over $100,000. At September 30, 2006, the
amount at risk was approximately $1,677,000.




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The significant outstanding accounts receivable balances in 2006 were as follows:
 September 30
    
    March 31Customer A**
    
    
    32.8
    %
    
    
    25.4
    %Customer B**
    
    
    10.5
    %
    
    
    *Customer C
    
    
    *
    
    
    
    21.6
    %Customer D
    
    
    15.3
    %
    
    
    *
 
 *
    
    Indicates receivables balance less than 10% of the Companys net accounts receivable balance.**
    
    Indicates national chain customer. 5.
    
    Inventories
 Inventories in 2006 are summarized as follows:
 September 30
    
    
    March 31Finished goods
    
    $
    2,097,000
    
    
    $
    1,706,000Work-in-process
    
    
    1,647,000
    
    
    
    1,234,000Raw materials
    
    
    2,559,000
    
    
    
    3,441,000$
    6,303,000
    
    
    $
    6,381,000
 6.
    
    Line of CreditIn December 2005, the Company entered into a $1 million revolving line of credit agreement
that expires in December 2006. Advances under the line of credit bear interest at the banks
prime rate (8.25% at September 30, 2006) and are secured by inventories and accounts
receivable. Under the terms of the credit agreement, the Company is required to maintain a
specific working capital, net worth, profitability levels, and other specific ratios. In
addition, the agreement prohibits the payment of cash dividends and contains certain
restrictions on the Companys ability to borrow money or purchase assets or interests in other
entities without prior written consent of the bank. At September 30, 2006, the Company was not
in compliance with certain of the covenants related to profitability and is currently
renegotiating changes to the line of credit. There were no borrowings under the line of credit
at September 30, 2006.7.
    
    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 capital lease
obligation of $7,000 is included in accounts payable. Amortization of plant equipment under
capital leases is included in depreciation expense.




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8.
    
    Loss Per Common ShareFollowing is a reconciliation of the numerators and denominators used in the calculation of
basic and diluted loss per common share:
 Three Months Ended
    
    
    Six Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Basic loss per share:Numerator-net loss
    
    $
    (307,000
    )
    
    $
    (210,000
    )
    
    $
    (423,000
    )
    
    $
    (252,000
    )Denominator-weighted average
common shares outstanding
    
    
    10,169,000
    
    
    
    10,141,000
    
    
    
    10,169,000
    
    
    
    10,137,000Basic loss per share
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.04
    )
    
    $
    (0.02
    )Diluted loss per share:Numerator-net loss
    
    $
    (307,000
    )
    
    $
    (210,000
    )
    
    $
    (423,000
    )
    
    $
    (252,000
    )Denominator-weighted average
common shares outstanding
    
    
    10,169,000
    
    
    
    10,141,000
    
    
    
    10,169,000
    
    
    
    10,137,000Diluted effect of common stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,169,000
    
    
    
    10,141,000
    
    
    
    10,169,000
    
    
    
    10,137,000Diluted loss per share
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.04
    )
    
    $
    (0.02
    )
 Options to purchase 935,000 shares of common stock at prices ranging from $0.50 to $11.50
per share and 1,003,000 shares of common stock at prices ranging from $0.50 to $12.54 were not
included in the computation of diluted earnings per share for the three and six-month periods
ended September 30, 2006 and 2005, respectively, because their effect would have been
anti-dilutive.9.
    
    Income Tax ExpenseBased on managements earnings projections for the fiscal year ended 2007, the Company has
forecasted an effective tax rate of 26 percent. The Company has California net operating loss
carryforwards of $2,679,000 of which $606,000 expires in 2007 and the remaining balance expires
in 2013. 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 be realized and
has established a valuation allowance against the California net operating loss carryforward
expiring in 2007.




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10.
    
    Geographic InformationThe Company has one reportable operating segment. Geographic information regarding the
Companys net sales is as follows:
 Three Months Ended
    
    
    Six Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005United States
    
    $
    3,788,000
    
    
    $
    4,547,000
    
    
    $
    8,142,000
    
    
    $
    9,656,000Canada
    
    
    33,000
    
    
    
    40,000
    
    
    
    87,000
    
    
    
    96,000Japan
    
    
    69,000
    
    
    
    72,000
    
    
    
    194,000
    
    
    
    260,000Europe
    
    
    1,004,000
    
    
    
    633,000
    
    
    
    1,858,000
    
    
    
    1,105,000All other countries
    
    
    89,000
    
    
    
    83,000
    
    
    
    178,000
    
    
    
    153,000$
    4,983,000
    
    
    $
    5,375,000
    
    
    $
    10,459,000
    
    
    $
    11,270,000
 All long-lived assets are located in the United States.Sales of OXYMATIC®, LOTUS and CYPRESS OXYPneumatic® conservers and SAGE Therapeutic devices
accounted for 72% and 69% of the Companys sales for the six-month periods ended September 30,
2006 and 2005, respectively, and 73% and 71% of the Companys sales for the three-month periods
ended September 30, 2006 and 2005, respectively.11.
    
    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 six-month period ended September 30, 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 will recognize compensation expense based on the
estimated grant date fair value method using the Black-Scholes valuation model. For these
awards, the Company will 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 six-month period ended September 30, 2006 has
been reduced for estimated forfeitures. For the six-month period ended September 30, 2006
stock-based compensation expense of $60,000 was recorded to selling, general, and administrative
expenses. Of the $60,000 in stock-based compensation, $20,000 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 705,000 were available for future grant at September 30, 2006.
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. In fiscal year 2006, 40,000
options were issued with vesting periods less than one year. All options granted to date have
ten-year contractual terms from the date of the grant.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 three
months ended September 30, 2006. The following weighted-average assumptions were used in
calculating the fair value of stock options granted during the six months ended June 30, 2005
using the Black-Scholes option valuation model:
 Expected life (in years)
    
    
    8.0Expected volatility factor
    
    
    79.0
    %Risk free interest rate
    
    
    4.3
    %Dividend yield
    
    
    0.0Forfeiture rate
    
    
    4.0
    %
 A summary of stock option activity as of and for the quarter ended September 30, 2006 is
presented below:
 RemainingExercise
    
    Contractual
    
    AggregatePrice Per
    
    Term
    
    Intrinsic ValueShares
    
    Share
    
    (in years)
    
    (in thousands)Outstanding at March 31, 2006
    
    
    945,000
    
    
    $
    2.22Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Forfeited or expired
    
    
    10,000
    
    
    
    3.59Outstanding at September 30, 2006
    
    
    935,000
    
    
    $
    2.20
    
    
    
    4.6
    
    
    $
    As of September 30, 2006:Exercisable
    
    
    898,000
    
    
    $
    2.22
    
    
    
    4.5
    
    
    $
    Vested and expected to vest
    
    
    925,000
    
    
    $
    2.25
    
    
    
    4.6
    
    
    $
    
 The Company granted 25,000 options at $3.45 per share on July 28, 2005 and 15,000 options
at $3.35 per share on August 2, 2005. The options were granted at the market price on the day
of grant, and fully vested six months subsequent to the grant date. In addition, there were
10,000 options exercised at prices ranging from $.50 to $1.00 in




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the six months ended September 30, 2005. No options were granted or exercised during the first
six months of fiscal year 2007.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 September 30, 2006 for
the options that were in-the-money at September 30, 2006. As of September 30, 2006, there was
approximately $31,000 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 13 months.Prior to the adoption of FAS 123R, the Company provided the disclosures required under FAS 123,
as amended by FAS No. 148, Accounting for Stock-Based Compensation  Transitions and
Disclosures. Employee stock-based compensation expense recognized under FAS 123R was not
reflected in our results of operations for the six-month period ended September 30, 2005 as all
options were granted with an exercise price equal to the market value of the underlying common
stock on the date of the grant. The pro forma information for the three and six-months ended
September 30, 2005 is as follows:
 Three Months Ended
    
    
    Six Months EndedSeptember 30, 2005
    
    
    September 30, 2005Net loss, as reported
    
    $
    (210,000
    )
    
    $
    (252,000
    )Deduct: Total stock-based employee
compensation expense determined under
fair value-based method for all awards, net
of related tax effects
    
    
    35,000
    
    
    
    70,000Pro forma net loss
    
    $
    (245,000
    )
    
    $
    (322,000
    )Loss per share:Basic  as reported
    
    $
    (0.02
    )
    
    $
    (0.02
    )Basic  pro forma
    
    
    (0.02
    )
    
    
    (0.03
    )Diluted  as reported
    
    
    (0.02
    )
    
    
    (0.02
    )Diluted  proforma
    
    $
    (0.02
    )
    
    $
    (0.03
    )
 12.
    
    Use of EstimatesThe preparation of financial statements in conformity with U.S. generally accepted accounting
principles 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.13.
    
    Accounting StandardsIn 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 the 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




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Company adopted SFAS No. 151 on April 1, 2006, and the Company did
not incur a significant impact to 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. The Company adopted SFAS 123R on April 1, 2006, and the Company did not incur a
significant impact to its financial statements.In June 2006, the Financial Accounting Standards Board ratified EITF Issue No. 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should be Presented in the
Income Statement. The EITF provides guidance on the proper presentation of tax assessed by a
governmental authority that is directly imposed on a revenue-producing transaction between a
seller and a customer and requires disclosure of the Companys accounting policy decision. The
consensus becomes effective for periods beginning after December 15, 2006. The Company is
evaluating the impact of this interpretation and does not anticipate a significant impact to
its financial statements upon implementation.In June 2006, the Financial Accounting Standards Board issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes. Interpretation No. 48 prescribes a recognition
threshold and measurement attribute for financial statement recognition and measurement of a
tax position taken, or expected to be taken, in a tax return. The Interpretation also
provides guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. This Interpretation is effective for fiscal years
beginning after December 15, 2006. The Company is evaluating the impact of this interpretation
and does not anticipate a significant impact to its financial statements upon implementation.In September 2006, the Financial Accounting Standards Board issued Staff Accounting Bulletin
No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements. SAB 108 requires registrants to quantify misstatements
using both the balance sheet and income-statement approaches and to evaluate whether either
approach results in quantifying an error that is material in light of relevant quantitative and
qualitative factors. The requirements are effective for annual financial statements covering
the first fiscal year ending after November 15, 2006. The Company is evaluating the impact of
this interpretation and does not anticipate a significant impact to its financial statements
upon implementation.In September 2006, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 157 Share-Based Payment. SFAS 157 establishes a single
authoritative definition of fair value, sets out a framework for measuring fair value, and
requires additional disclosures about fair-value measurements. SFAS 157 applies only to
fair-value measurements that are already required or permitted by other accounting standards.
The Statement is effective for fair-value measures already required or permitted by other
standards for financial statements issued for fiscal years beginning after November 15, 2007
and interim periods within those fiscal years. The Company is evaluating the impact of this




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interpretation and does not anticipate a significant impact to its financial statements upon
implementation.In September 2006, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standard (SFAS) No. 158 Employers Account for Defined Benefit Pension and Other
Post-retirement Plans. SFAS 158 requires employers to recognize on their balance sheets the
funded status of pension and other post-retirement benefit plans  as of December 31, 2006 for
the calendar year public companies. SFAS 158 will also require fiscal-year-end measurements of
plan assets and benefit obligations, eliminating the use of earlier measurement dates currently
permissible. The Company does not have a defined benefit pension plan, nor does it have any
other post-retirement plans and therefore does not anticipate a significant impact to its
financial statements upon implementation.




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®




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®
  
    
    Development of additional oxygen conserver models, such as the
LOTUS Electronic Oxygen Conserver with a view to diversifying 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; and
    
    A continued promotional and educational campaign with respect to
the benefits of the TOTAL O2 system.




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Payments Due by PeriodLess than 1
    
    
    1  3
    
    
    3-5
    
    
    After 5Total
    
    
    Year
    
    
    Years
    
    
    Years
    
    
    YearsContractual
Cash ObligationsOperating lease
obligations
    
    $
    847,000
    
    
    $
    452,000
    
    
    $
    395,000
    
    
    
    
    
    
    
    Minimum royalty
obligations
    
    $
    2,805,000
    
    
    $
    523,000
    
    
    $
    1,590,000
    
    
    $
    632,000
    
    
    $
    60,000Employee obligations
    
    $
    400,000
    
    
    $
    160,000
    
    
    $
    240,000
    
    
    
    
    
    
    
    Capital lease
obligations
    
    $
    7,000
    
    
    $
    7,000
    
    
    
    
    
    
    
    
    
    
    
    




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(a)
    
    The Companys 2006 Annual Meeting of Shareholders was held on October 24,
2006 in Woodland Hills, California.(b)
    
    Proxies for the meeting were solicited pursuant to Regulation 14 under the
Securities Exchange Act of 1934, as amended, there was no solicitation in opposition
to the managements nominees as listed in the proxy statement, and all such nominees
were elected.(c)
    
    At the Annual Meeting, the following matters were considered and voted upon:
 (i)
    
    The election of three directors to the Companys board of
directors, which currently consists of seven persons. Only three positions on
the Companys board of directors were to be elected at the Annual Meeting. At
the Annual Meeting, the Companys shareholders elected each of the following
director nominees as directors, to serve on the Companys board of directors
until the Annual Meeting of Shareholders 2007 or until their successors are
duly elected and qualified. The vote of each director was as follows:
 Name
    
    For
    
    Against
    
    WithheldThomas E. Jones
    
    
    8,612,270
    
    
    
    0
    
    
    
    628,356John C. Boyd
    
    
    8,609,820
    
    
    
    0
    
    
    
    630,806Earl L. Yager
    
    
    8,613,267
    
    
    
    0
    
    
    
    627,359
 (ii)
    
    To ratify the appointment of KPMG LLP as the Companys independent
auditors for the fiscal year ended March 31, 2007. At the Annual Meeting, the
Companys shareholders approved this proposal by the votes indicated below:
 SharesFor
    
    
    8,774,879Against
    
    
    411,988Abstain
    
    
    53,759




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(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(d) 99.1
    
    Press release dated November 14, 2006
 
 *
    
    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 11/14/2006
    
    /s/ Earl L. Yager

Earl L. YagerPresident and Chief Executive OfficerDate 11/14/2006
    
    /s/ Tracy A. KernTracy 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 November 14, 2006
 
 *
    
    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.