CTU Chad Therapeutics,

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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CHAD THERAPEUTICS, INC.

21622 Plummer Street

Chatsworth, California 91311

(818) 882-0883

 

 

CHAD THERAPEUTICS, INC.

21622 Plummer Street

Chatsworth, California 91311

(818) 882-0883

 

 

NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD January 31, 2008

 

 

Notice is hereby given that a special meeting of shareholders of CHAD Therapeutics, Inc. will be held at our principal executive offices at 21622 Plummer Street, Chatsworth, California 91311 on the 31st day of January, 2008 at 10:00 a.m., local time, for the following purposes:

 

1. To consider and vote upon a proposal to approve the sale of our 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 (“Inovo”), and CHAD Therapeutics, Inc., a California corporation. Pursuant to the Asset Purchase Agreement, CHAD would sell substantially all of the assets related to its oxygen conserver business to Inovo and Inovo would assume certain liabilities related to the oxygen conserver business (the “Asset Sale”).

 

2. To consider and vote upon a proposal to adjourn the special meeting for the purpose of soliciting additional proxies, if necessary, with respect to the Asset Sale.

 

3. To act on any other business properly presented at the special meeting or any postponements or adjournments thereof.

 

Pursuant to the Bylaws of the Company, the Board of Directors has fixed December 24, 2007, as the record date for the determination of such shareholders entitled to notice of and to vote at the Meeting, and all adjournments thereof, and only shareholders of record at the close of business on that date are entitled to such notice and to vote at the Meeting. You are cordially invited to attend the special meeting in person.

 

Any proxy may be revoked at any time prior to its exercise by delivery of a later-dated proxy, using the toll-free telephone number or Internet website address or by voting in person at the special meeting.

 

We ask that you vote your shares as described above regardless of whether you plan to attend the special meeting in person. If you fail to return your proxy card or fail to submit your proxy by telephone or Internet and do not attend the special meeting in person, your shares will not be counted for purposes of determining whether a quorum is present at the special meeting, and if a quorum is present, will have the same effect as a vote against approval of the Asset Sale.

 

A complete list of our shareholders entitled to vote at the special meeting, or any adjournment thereof, will be available for inspection by shareholders during normal business hours at our offices located at 21622 Plummer Street, Chatsworth, California 91311, beginning the earlier of ten days prior to the special meeting or two business days after delivery of this notice. Such list will also be available for examination at the special meeting.

 

By Order of the Board of Directors,

 

Paula O’Connor

Secretary

 

December 28, 2007

 

 

 

 

If you have any questions or need assistance in voting your shares, please call our proxy solicitor, Morrow & Co., LLC at 1-800-607-0088.

 

TABLE OF CONTENTS

 

CHAD THERAPEUTICS, INC.

21622 Plummer Street

Chatsworth, California 91311

California 91311

(818) 882-0883

 

PROXY STATEMENT

 

December 28, 2007

 

SUMMARY

 

The following summary highlights selected information about the Asset Sale and the special meeting and may not contain all of the information that may be important to you. Accordingly, we encourage you to read carefully this entire proxy statement, its annex and the documents referred to or incorporated by reference in this proxy statement. In this proxy statement, the terms “CHAD,” “Company,” “we,” “our,” “ours,” and “us” refer to CHAD Therapeutics, Inc. and its subsidiaries.

 

The Special Meeting

 

Time, Place and Purpose of the Special Meeting

 

A special meeting of shareholders will be held on January 31, 2008, beginning at 10:00 a.m., local time, at our principal executive offices at 21622 Plummer Street, Chatsworth, California 91311 for the following purposes:

 

1. To consider and vote upon a proposal to approve the sale of our 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 (“Inovo”) and CHAD Therapeutics, Inc. Pursuant to the Asset Purchase Agreement, CHAD would sell substantially all of the assets related to its oxygen conserver business to Inovo and Inovo would assume certain liabilities related to the oxygen conserver business (the “Asset Sale”).

 

2. To consider and vote upon a proposal to adjourn the special meeting for the purpose of soliciting, if necessary, additional proxies with respect to the Asset Sale.

 

3. To act on any other business properly presented at the special meeting or any postponements or adjournments thereof.

 

Recommendation of CHAD’s Board of Directors; Reasons for the Asset Sale

 

The Board of Directors has concluded that, as a small public company, CHAD cannot compete effectively in the oxygen therapy business, which has been characterized in recent years by pressure on selling prices and reduction in, and uncertainty with respect to, government reimbursement policies. After considering a wide variety of strategic alternatives and conducting an extensive market test process with the assistance of Ewing, Bemiss & Co. (“Ewing Bemiss”), an independent investment banking firm, our Board of Directors has:

 

 

The Board of Directors believes the Asset Sale is in the best interests of the Company and its shareholders for the following reasons:

 

 

Effect of the Asset Sale on CHAD

 

Our business currently consists of the following elements:

 

 

We manufacture and sell oxygen conservers and therapeutic devices for use by ambulatory patients requiring supplementary oxygen under the brand names: OXYMATIC, OXYMIZER, LOTUS, BONSAI, SEQUOIA, CYPRESS and SAGE. Sales of oxygen conservers and related products accounted for approximately 94% and 91% of our sales for the six month and twelve month periods ended September 30, 2007 and March 31, 2007, respectively. The assets related to our oxygen conserver business comprised approximately 54% of the book value of our total assets as of September 30, 2007.

 

If the Asset Sale is approved, the oxygen conserver business and related assets will be sold to Inovo.

 

 

We manufacture and sell transfilling systems which combine stationary and ambulatory oxygen systems in a single device. Patients requiring supplementary oxygen may use these systems to provide stationary oxygen in their homes and to fill their portable oxygen cylinders. The systems are sold under the brand names: TOTAL O ₂ , OMNI-2 and OMNI-5. We refer to our oxygen conserver business and the transfilling business together as our “oxygen therapy business.” Sales of transfilling systems accounted for approximately 6% and 9% of our sales for the six month and twelve month periods ended September 30, 2007 and March 31, 2007, respectively. The assets related to our transfilling business comprised approximately 25% of the book value of our total assets as of September 30, 2007.

 

We are currently seeking a buyer for our transfilling business. The assets related to this business are not part of the Asset Sale.

 

 

We are currently engaged in the development of products for the sleep disorder market. These products are intended to assist physicians and sleep labs in diagnosing and treating patients with sleep disorders such as sleep apnea. None of these products has been commercially introduced. In the next thirty days, we currently expect to file with the Food & Drug Administration an application for approval to market our first device. Our other sleep disorder products are undergoing further development and pre-clinical testing. The assets related to our sleep disorder products consist primarily of intellectual property rights, product prototypes and related parts. As of September 30, 2007, these assets comprised approximately 21% of the book value of our total assets.

 

We intend to use the net proceeds from the Asset Sale to fund further development and commercialization of our products for the sleep disorder market. We anticipate that the net proceeds from the Asset Sale after payment of all our secured debt and certain other obligations will be approximately $1.1 million.

 

Record Date, Quorum and Voting Power

 

You are entitled to vote at the special meeting if you owned shares of our common stock at the close of business on December 24, 2007, the record date for the special meeting. Each record holder of shares of our common stock is entitled to cast one vote per share on each proposal, in accordance with our articles of incorporation. Approval of the Asset Sale requires the affirmative vote of a majority of our outstanding shares. As of the record date, there were 10,179,759 shares of common stock outstanding.

 

The holders of a majority of the shares of common stock outstanding on the record date, represented in person or by proxy, will constitute a quorum for the special meeting.

Voting by Directors and Executive Officers

 

As of the record date, our directors and executive officers held and are entitled to vote, in the aggregate, 857,633 shares of our common stock, representing approximately 8.42% of the outstanding shares of our common stock entitled to vote on the proposals. We have been informed by our directors and executive officers that they intend to vote all of their shares “FOR” approval of the Asset Sale.

 

Proxies; Revocation

 

If you hold shares in your name as the shareholder of record, then you received this proxy statement and a proxy card from us. If you hold shares in street name through a broker, bank or other nominee, then you received this proxy statement from the nominee, along with the nominee’s form of proxy card, which includes voting instructions. In either case, you may vote your shares by Internet, telephone or mail without attending the special meeting. To vote by Internet or telephone 24 hours a day, seven days a week, follow the instructions on the proxy card. To vote by mail, mark, sign and date the proxy card and return it in the postage-paid envelope provided with this proxy statement.

 

Internet and telephone voting provide the same authority to vote your shares as if you returned your proxy card by mail. In addition, Internet and telephone voting will reduce our proxy-related postage expenses.

 

You may revoke your proxy at any time before the vote is taken at the special meeting. To revoke your proxy, you must either: (i) advise our Corporate Secretary in writing, (ii) deliver a new executed proxy dated after the date of the proxy you wish to revoke, (iii) submit another vote over the Internet or by telephone, in each case after the date of the proxy you wish to revoke, or (iv) attend the special meeting and vote your shares in person. Attendance at the special meeting will not by itself constitute revocation of a proxy. If you have instructed your broker to vote your shares, the above-described options for revoking your proxy do not apply and instead you must follow the directions provided by your broker to change these instructions.

 

Approval of Proposed Asset Sale Pursuant to the Asset Purchase Agreement

 

We are asking our shareholders to approve the sale of our oxygen conserver business to Inovo pursuant to the Asset Purchase Agreement for the purchase price of $5,250,000 in cash (the “Purchase Price”), subject to an adjustment for changes in our net working capital as of the closing date. The Purchase Price may not exceed $5,500,000. There is no limit on the potential downward adjustment of the Purchase Price if we suffer a decline in our working capital related to the oxygen conserver business. If the Asset Sale had closed as of October 31, 2007, the Purchase Price would have been $5,161,000.

 

If our shareholders approve the Asset Sale, we will sell to Inovo substantially all of the assets used in our oxygen conserver business, including without limitation manufacturing equipment and tools, inventory, accounts receivable, contract rights, licenses and permits, patents, trademarks and other intellectual property, the name “CHAD” and associated goodwill. In addition, Inovo would assume certain liabilities related to our oxygen conserver business including trade accounts payable, liabilities under assumed contracts and warranty obligations, not to exceed $100,000, on oxygen conservers sold by us prior to the closing date. We would continue to be responsible for all liabilities not expressly assumed by Inovo.

 

If the Asset Sale is approved, we will use a substantial portion of the proceeds to pay all of our outstanding secured debt. After payment of such debt, employee termination expenses, transaction expenses, and funding of operating losses between now and the anticipated closing date, we estimate our net proceeds to be $1,100,000, which will be used to continue the development and marketing of our products for the sleep disorder market. In addition, we will continue to own the assets related to our transfilling business; however, we are actively seeking a buyer for that business. We do not intend to distribute any of the net proceeds from the Asset Sale to our shareholders. See “Approval of Proposed Asset Sale Pursuant to Asset Purchase Agreement” and “The Asset Purchase Agreement — The Transaction.”

 

If the Asset Sale is not approved or otherwise not completed, we expect to significantly curtail our business operations and commence the liquidation of our assets. Our negative cash flow during the past six months has been largely financed through a secured line of credit. However, we have exhausted our borrowing capacity under this

line of credit. In order to meet our immediate cash requirements we have entered into an agreement with two of our executive officers to borrow $300,000 with a potential of borrowing an additional $700,000. In addition we might obtain additional capital through a sale of our transfilling assets or through the sale of our stock or other securities, but we have no definitive agreements in place for any such transaction and there is substantial doubt that we would be able to raise sufficient funds in a time frame which would enable us to continue our business operations. In connection with the potential liquidation of our assets, the provider of our secured credit line might foreclose upon our operating assets or we might seek protection under the federal bankruptcy laws.

 

The Parties to the Transaction

 

CHAD Therapeutics, Inc.

 

21622 Plummer Street

Chatsworth, California 91311

(818) 882-0883

 

CHAD Therapeutics, Inc., a California corporation (“CHAD” or the “Company”), was organized in August 1982 to develop, produce, and market respiratory care devices designed to improve the efficiency of oxygen delivery systems for both home and hospital treatment of patients who require supplemental oxygen. The Company introduced its first respiratory care device in 1983 and has introduced additional respiratory care devices in subsequent years. Our principal office is located at 21622 Plummer Street, Chatsworth, California 91311. Our telephone number is (818) 882-0883. Our Internet address is www.chadtherapeutics.com.

 

Inovo, Inc

 

2975 Horseshoe Drive South, Suite 600

Naples, Florida 34104

(239) 643-6577

 

Inovo, Inc., a Florida corporation (“Inovo”), is a privately held company based in Naples, Florida and is a leading manufacturer of oxygen regulators and conserving devices, serving the home healthcare, emergency medical service and hospital markets.

 

See “The Asset Purchase Agreement — The Parties to the Asset Purchase Agreement.”

 

Transition Services Agreement

 

If we enter into the Asset Sale, we will provide certain transition services to Inovo for a period that will end no later than June 15, 2008. During the transition period, we will continue to manufacture oxygen conservers in our Chatsworth facility for sale by Inovo and provide certain other services to assist Inovo with the operation of the oxygen conserver business. Inovo will reimburse us in full for all operating expenses incurred in connection with providing these transition services. Inovo is required to transfer the oxygen conserver operations to its facilities in Naples, Florida no later than June 15, 2008.

 

Employee Matters

 

Inovo has advised us that it intends to hire 13 of our employees, including Oscar Sanchez, our Vice President of Business Development.

 

Our employees who are exclusively engaged in the oxygen conserver business and who are not hired by Inovo will be terminated as of the end of the transition services period. We currently anticipate terminating 77 employees. Such terminations will be subject to the WARN Act under federal law which requires us to give not less than 60 days prior notice of such terminations. We currently anticipate that we will incur approximately $421,000 of termination related expenses in connection with the Asset Sale. See also the discussion below under “Interests of CHAD’s Executive Officers.”

 

After completion of the Asset Sale and transition services period, we anticipate we will have approximately six employees.

Indemnification

 

We have agreed to indemnify Inovo for any and all damage, loss, liability and expense, including all reasonable expenses of investigation and reasonable attorneys’ fees, including in connection with any action, suit or proceeding involving a third-party claim or a claim solely between us and Inovo arising out of:

 

 

Our indemnity obligations with respect to Excluded Liabilities are unlimited under the Asset Purchase Agreement. Otherwise, subject to certain exceptions, our indemnity obligations only apply to claims made within two years of the closing of the Asset Sale.

 

Approximately 6.7% of the Purchase Price ($350,000) will be placed in an escrow account for up to 180 days following closing of the Asset Sale. Inovo will have recourse to the monies held in escrow with respect to any post-closing working capital adjustments or indemnification claims it might have. See “The Asset Purchase Agreement — Survival; Indemnification.”

 

No Solicitation of Transactions; Competing Offer

 

The Asset Purchase Agreement restricts our ability to solicit or engage in discussions or negotiations with, or provide information to, third parties regarding competing transactions for the oxygen conserver business. Our Board of Directors may, however, respond to certain unsolicited proposals from third parties. We are required to notify Inovo immediately if we receive an unsolicited proposal for a competing offer. Our Board of Directors may terminate the Asset Purchase Agreement under certain circumstances and agree to a competing offer, so long as CHAD complies with certain terms of the Asset Purchase Agreement. We are obligated to pay Inovo a termination fee of $200,000 if our Board of Directors withdraws its recommendation in favor of the Asset Sale or if we complete a competing transaction within 12 months after the Asset Purchase Agreement is terminated (other than as a result of Inovo’s breach). See “The Asset Purchase Agreement — No Solicitation of Competing Offers; Right to Consider Superior Proposal.”

 

Termination of the Purchase Agreement

 

Inovo may terminate the Asset Purchase Agreement if the conditions to closing, including receipt of approval by the shareholders of CHAD, have not been satisfied by March 31, 2008. In addition, either party may terminate the Asset Purchase Agreement if the other party is in material breach of a representation or covenant that is not cured within 30 days. We may terminate the Asset Purchase Agreement at any time and enter into a competing transaction subject to the requirements discussed in “The Asset Purchase Agreement — No Solicitation of Transactions; Competing Offer” above. The parties may also terminate the Asset Purchase Agreement at any time by mutual consent. See “The Asset Purchase Agreement — Termination of the Purchase Agreement.”

 

Fees and Expenses

 

Generally, if the Asset Sale is completed, or if either party terminates the Asset Purchase Agreement for any reason allowed under its terms, the parties are responsible for their own transaction expenses. In addition, we have agreed to pay Inovo a termination fee of $200,000 under certain circumstances described above. See “The Asset Purchase Agreement — Fees and Expenses.”

 

Tax Consequences of the Asset Sale to our Shareholders

 

Our shareholders will not receive any of the proceeds from the Asset Sale and therefore the transaction will not be a taxable event for federal income tax purposes to our shareholders. See “The Asset Purchase Agreement — Material U.S. Federal Income Tax Consequences of the Asset Sale Transaction.”

Interests of CHAD’s Executive Officers

 

When considering whether to approve the Asset Sale, you should be aware that our executive officers may be deemed to have an interest in the Asset Sale in addition to their interests as CHAD shareholders, that may be different from, or conflict with, your interests as a CHAD shareholder.

 

In order to enhance our near-term liquidity, on December 19, 2007, our Board of Directors approved a credit facility with Mr. Earl Yager and Mr. Thomas Jones, our Chief Executive Officer and our Chairman of the Board, respectively (the “Credit Facility”). Pursuant to the terms of the Credit Facility, we may draw an aggregate of $1,000,000, subject to certain conditions. We made an initial draw down in the principal amount of $300,000.

 

Notes issued under the Credit Facility will 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 Asset Sale or (ii) August 30, 2010. The notes will be secured by the assets of the Company, but the security interest will be subordinated to the security interest of Calliope Capital Corporation discussed below. In connection with the Credit Facility, Mr. Yager and Mr. Jones each will receive warrants to purchase our common stock at a price per share equal to 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 (“Exercise Price”). 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 we may make under the Credit Facility.

 

The Board of Directors appointed two independent members of the Board to evaluate and negotiate the terms of the Credit Facility. Neither Mr. Yager nor Mr. Jones participated in the meeting of the Board of Directors which approved the Credit Facility. In its evaluation of the Credit Facility, the independent members of the Board of Directors considered the terms of other potential funding sources and determined that the Credit Facility was more favorable to the Company and its shareholders than the terms proposed by other sources of funding. The Board of Directors also consulted with financial and legal advisers and considered the Company’s current financial condition, its recent operating performance and market conditions for distressed borrowers in its evaluation of the Credit Facility.

 

We expect that several of our executive officers will be terminated following the Asset Sale and will be entitled to severance payments as set forth below.

 

In addition, we have entered into change in control severance agreements with each of our executive officers. The severance agreements were entered into under a Severance and Change in Control Policy that we adopted in 1997 and have been consistently used for substantially all of our employees, including our executive officers. The severance agreements provide for payments if the employee is terminated within two years of a change in control of the Company. The amount payable varies by position; our executive officers would be entitled to a severance payment equal to two times their annual salary if they are terminated within two years of a change in control of the Company. Our Board of Directors has determined that the Asset Sale will not, in and of itself, constitute a change in control under the Severance and Change in Control Policy. However, if, in addition to the Asset Sale, we sell all or a substantial portion of our remaining assets, or if we sell the Company, then severance payments could be triggered for our executive officers. The table below sets forth information about possible additional severance payments that could become payable to our executive officers in the future. See “Approval of Proposed Asset Sale Transaction Pursuant to Asset Purchase Agreement — Interests of CHAD’s Executive Officers.”

 

 

Appraisal Rights

 

Our shareholders do not have appraisal rights under California law in connection with the Asset Sale. See “Approval of Proposed Asset Sale Transaction Pursuant to Asset Purchase Agreement — Appraisal Rights.”

 

Required Vote

 

All holders of CHAD’s common stock on the record date are entitled to vote on the approval of the Asset Sale. The affirmative vote of a majority of the votes entitled to be cast is required to approve the Asset Sale. See “The Special Meeting — Required Vote; Abstentions; Broker Non-Votes.”

 

QUESTIONS AND ANSWERS ABOUT THE SPECIAL MEETING AND THE PROPOSALS

 

The following questions and answers address briefly some questions you may have regarding the special meeting and the proposed Asset Sale. These questions and answers may not address all questions that may be important to you as a shareholder of CHAD Therapeutics, Inc. Accordingly, we encourage you to read carefully this entire proxy statement, its annexes and the documents referred to or incorporated by reference in this proxy statement.

 

 

 

 

Morrow & Co, LLC
470 West Avenue
Stamford, CT 06902
(203) 658-9400 (Call Collect)
(800) 607-0088 (Call Toll-Free)
E-mail: chad.info@morrowco.com

 

RISK FACTORS

 

In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, set forth below are cautionary statements identifying important factors that could cause actual events or results to differ materially from any forward-looking statements made by us or on our behalf, whether oral or written. We wish to ensure that any forward-looking statements are accompanied by meaningful cautionary statements in order to maximize to the fullest extent possible the protections of the safe harbor established in the Private Securities Litigation Reform Act of 1995. Accordingly, any such statements are qualified in their entirety by reference to, and are accompanied by, the following important factors that could cause actual events or results to differ materially from our forward-looking statements.

 

In addition to the other information included in this proxy statement, you should consider carefully the matters described below in evaluating the proposed Asset Sale as well as our business. Additional risks and uncertainties that are not presently known to us or that we do not currently believe to be important to you also may adversely affect our business, and the Asset Sale.

 

RISKS IF THE ASSET SALE IS CONSUMMATED

 

If the Asset Sale is consummated, we will depend upon our unproven products for the sleep disorder market for our future success.

 

If the Asset Sale is consummated, we will endeavor to sell our transfilling assets as quickly as possible, and thereafter focus our efforts on the development and commercialization of products for the sleep disorder market. If this strategy is implemented, our future results will depend upon our ability to successfully complete the development of our sleep disorder products and our ability to commercially introduce such products. These products are electro-mechanical devices designed to be used by physicians and sleep clinics to diagnose and treat sleep disorders such as apnea. All of our historical revenues have been generated from the sale of oxygen therapy products. None of our sleep disorder products are currently available on a commercial basis. Several remain in the development stage. We expect to begin marketing the first of our sleep disorder products in the first calendar quarter of 2008.

 

We face significant challenges in executing our plan to enter the sleep disorder market. None of our sleep disorder products have been commercially proven and we do not have an established presence in this sector of the health care market. We will face competition from several well established manufacturers of products for the sleep disorder market, all of whom have substantially greater financial and marketing resources than we have. Our ability to enter this market will depend upon proving the efficacy of our products, persuading physicians, sleep clinics and others of the efficacy and technical advantages which we believe our sleep disorder products will offer, developing a strategy for marketing our sleep disorder products and obtaining the financial resources to support these efforts. As with any business which has not established its commercial viability, there is a high risk that we will fail in our efforts to implement this strategy.

 

Most of our sleep disorder products remain in the development stage and we do not know when, if ever, we will generate any revenues from such products.

 

Most of our products for the sleep disorder market remain in the development stage. Before we can commercially introduce such products, we must complete the development process, undertake clinical tests to demonstrate the efficacy and safety of such products, modify the products to the extent that clinical testing indicates further improvements are necessary and obtain marketing approval from the Food & Drug Administration. Each of these steps is subject to multiple risks which could prevent or delay the commercial introduction of such products. As a result, it is not possible for us to predict when, if ever, we will generate revenues from the sale of such products.

 

We will require additional financial resources to implement our strategy with respect to the sleep disorder market. Failure to obtain such resources will diminish our prospects for success.

 

In order to have adequate funding to expedite the development and commercialization of our sleep disorder products, we will require additional funding. Although several potential investors and strategic partners have

expressed a preliminary interest in our sleep disorder products, we do not currently have in place any commitments for funding to support our strategy for the sleep disorder market. If such funding is not obtained, then we will be dependent upon the net proceeds generated by the Asset Sale and the sale of our transfilling assets. We currently anticipate that the net proceeds from the Asset Sale, after payment of all of our secured obligations, termination expenses and transaction fees, will be approximately $1.1 million, which we anticipate will be sufficient to continue our operations for approximately 12 months. We do not know at this time how much cash we will receive, if any, from the sale of our transfilling assets. However, we expect that the total proceeds from such sale may not be sufficient to enable us to adequately market the sleep disorder products against the much larger competitors who currently dominate that market. If we do not generate adequate cash from a sale of the transfilling assets, then we will need to raise funds through the sale of equity or debt securities in order to be a viable competitor in the sleep disorder market.

 

If we do raise additional funding through the sale of securities to support our sleep disorder strategy, the terms of any such financing may significantly dilute the equity interests of our current shareholders. Moreover, such funding may be in the form of senior equity with liquidation and other preferences over our common stock. The funding could also be in the form of convertible or non-convertible debt which could place significant restrictions upon our business operations.

 

If we are unable to raise sufficient funds to implement our strategy for the sleep disorder market, then our prospects for success will be materially diminished as we will lack the ability to aggressively market our sleep disorder products.

 

Our future results will depend upon our ability to continue to successfully introduce new products. Difficulties encountered in introducing new products will harm our future operating results.

 

The sleep disorder market is subject to continuing technological change. Our products may become obsolete if we do not stay abreast of such changes and introduce new and improved products.

 

There are a number of significant risks involved with new product introductions. Problems encountered in the design and development of new products or in obtaining regulatory clearances to market the products may impair our ability to introduce any new product in a timely manner. Competitors may leapfrog our development efforts, particularly if our development efforts are delayed.

 

The commercial success of any new products we do introduce will depend upon the health care community’s perception of such products’ capabilities, clinical efficacy and benefit to patients. In addition, prospective sales will be impacted by the degree of acceptance achieved among patients suffering from sleep disorders. Our prospective customers may be reluctant to try unproven products which we introduce. Our ability to successfully introduce new products in a new market sector such as the sleep disorder market will also be complicated by our lack of experience and our lack of an established reputation in this market. Thus, the success of any new products we may introduce is unpredictable and our future results may suffer if we are unable to successfully introduce new products.

 

Failure to protect our intellectual property rights could hurt our ability to compete in the sleep disorder market.

 

The success of our strategy for the sleep disorder market is dependent to a significant extent upon our ability to develop products that have what we believe will be certain technical advantages over currently available sleep disorder products. Such technical advantages are derived from proprietary technologies and rights to patented inventions. Our ability to adequately protect such intellectual property rights is therefore crucial to our potential success in the sleep disorder market. We pursue a policy of protecting our intellectual property rights through a combination of patents, trademarks, license agreements, confidentiality agreements and protection of trade secrets. To the extent that our products do not receive patent protection, competitors may be able to market substantially similar products, thereby eroding our potential market share. Moreover, claims that our products infringe upon the intellectual property rights of any third party could impair our ability to sell certain products or could require us to pay license fees, thereby increasing our costs.

We may not generate any significant cash from the sale of our transfilling business.

 

If the Asset Sale is approved, we will continue our efforts to sell the assets related to our transfilling business. While several companies have indicated an interest in such assets, all such discussions are at a preliminary stage and we do not have any binding commitment to acquire such assets. Moreover, any sale of such assets will depend upon receiving the consent of the licensor for certain patented technologies used in the transfilling products. The licensor would only consent to the proposed sale of such assets to Inovo upon conditions which were not acceptable to Inovo. Although the companies with whom we are currently in discussions with respect to the transfilling assets are substantially larger than Inovo, no assurance can be given that the licensor will agree to consent upon terms which are acceptable to the proposed buyer of such assets, or that a sale of such assets can be successfully negotiated.

 

You will not receive any portion of the proceeds from the Asset Sale.

 

All of the proceeds from the Asset Sale will be received by the Company. We intend to use the net proceeds to fund development and commercialization of our products for the sleep disorder market. We do not intend to pay any dividend or make any distribution to shareholders from the proceeds of the Asset Sale. As a result, you will only benefit from the Asset Sale if (i) we are able to successfully implement our strategy for the sleep disorder market and your stock appreciates in value or (ii) we subsequently sell the Company or our sleep disorder assets at a price which represents a premium over your basis in our common stock.

 

You will not have the benefit of a fairness opinion in deciding whether or not to vote in favor of the Asset Sale.

 

Our Board of Directors decided not to obtain a fairness opinion in connection with the proposed Asset Sale. The sole reason for such decision was the cost entailed in obtaining a fairness opinion. The Board concluded that, in view of the two and a quarter years spent pursuing strategic options for the Company, the exhaustive efforts undertaken by Ewing Bemiss on several occasions to canvass the market for potential acquirers or bidders, the financial advice provided by Ewing Bemiss throughout this process, the Company’s continuing operating losses, the difficult market environment for oxygen therapy products and the Company’s limited alternatives to exiting the oxygen therapy business, the Board could exercise its duty of care in evaluating the Asset Sale without the benefit of a fairness opinion. The Board concluded that the funds that would be spent to obtain a fairness opinion could be better used in developing the Company’s sleep disorder products.

 

Because no fairness opinion has been obtained, you will not have the benefit of an independent expert’s evaluation of the fairness of the terms of the proposed Asset Sale to the shareholders of CHAD. Rather, you will only have the Board of Directors’ evaluation in this regard.

 

RISKS IF THE ASSET SALE IS NOT APPROVED

 

If the Asset Sale is not approved, there is substantial doubt about our ability to continue as a going concern.

 

We do not currently have sufficient capital resources to continue our historical operations for the next 12 months. We have incurred significant operating losses for more than two years and, during the six month period ended September 30, 2007, our negative cash flow from operations was approximately $1.7 million. We funded these losses largely from a secured credit line established in July 2007. However, we have exhausted our borrowing capacity under the credit line. Our available cash at September 30, 2007 was approximately $400,000.

 

In light of these factors, if the Asset Sale is not approved, we will likely be required to commence the liquidation of our operating assets. It is uncertain whether we will be able to realize fair value for our inventory, equipment, accounts receivable and other property under these circumstances. For example, customers may not pay full value for our products if they have concerns about our ability to service such products and honor our warranty obligations.

 

No assurance can be given that any such liquidation process would generate sufficient cash to meet our existing obligations. As a result, there is a possibility that our senior secured creditor could foreclose upon our assets or that

we would be forced to seek protection under federal bankruptcy laws. In either event, it is likely our shareholders would receive little or nothing of value following any foreclosure or bankruptcy proceedings.

 

If the Asset Sale is not approved, we will likely be unable to pursue development of our strategy for the sleep disorder market.

 

If the Asset Sale is not approved, we will lack sufficient cash to pursue further development and commercialization of our products for the sleep disorder market. Although several potential investors and strategic partners have indicated an interest in our sleep disorder products, they have been discouraged from pursuing such discussions by our on-going operating losses resulting from our oxygen therapy business. Moreover, the assets related to our sleep disorder products are all pledged as collateral on our secured credit line. Hence, unless this line is paid off, it will be extremely difficult for us to attract an investor or partner for continued development of the sleep disorder products. Our ability to pay down the secured credit line is dependent upon receiving the cash proceeds to be generated by the Asset Sale. While it is possible that the proceeds from the sale of our transfilling business will provide the funds necessary to pay our secured credit line, our discussions regarding the sale of the transfilling business are in a preliminary stage and we cannot predict at this time the proceeds we will receive, if any, from such a sale.

 

If the Asset Sale is not approved, our operating results, profitability and operating margins will continue to be adversely affected by price pressure on our principal products.

 

During the past several years, there has been significant price pressure on oxygen conservers and therapeutic devices. Thus, though our unit sales of conservers and therapeutic devices in fiscal 2007 showed a 10.1% decline, revenues from the sales of such products declined by 16.9%. This trend is magnified by the continuing consolidation of the home care industry as national chains typically negotiate for quantity discounts. Four major national chains accounted for 49% of our sales for the year ended March 31, 2007, up from 43% in the prior year. One customer accounted for 43%, 36% and 36% for the years ended March 31, 2007, 2006, and 2005, respectively. A second customer accounted for 11% of sales for the year ended March 31, 2005. One non-chain customer accounted for 11% of sales for the year ended March 31, 2006. Future sales may be increasingly dependent upon a limited number of customers which increase the risk that our financial performance may be adversely affected if one or more of these customers reduces their purchases of our products or terminates its relationship with us. During the past two years, a significant decline in orders from one national chain contributed to our decline in revenues. We expect continuing price pressure on our principal products for the foreseeable future. We do not believe we can compete effectively in the oxygen therapy market and, as a result, we are likely to commence a liquidation of our assets if the Asset Sale is not approved.

 

If the Asset Sale is not approved, we expect that continued uncertainty with respect to government reimbursement policies will continue to depress the market for our oxygen therapy products.

 

Approximately 80% of home health care patients are covered by Medicare and other government programs. Federal law has altered the payment rates available to providers of Medicare services. The Medicare Improvement and Modernization Act of 2003 has resulted in several years of reductions in reimbursement for home oxygen therapy. In February 2006, reimbursement procedures were modified again, with a new requirement that ownership of home oxygen equipment be transferred to the patient after 36 months. New proposals related to reimbursement for home health care are routinely introduced in Congress.

 

As a result, we expect changes in reimbursement policies to continue to exert downward pressure on the average selling price of our oxygen therapy products. Moreover, the uncertainty resulting from constant change in reimbursement policies has had a deleterious effect upon our market, causing many home care providers to delay or cut back their product purchase plans as they seek to evaluate the impact of the new policies.

If the Asset Sale is not approved, we expect that the highly competitive environment for oxygen therapy products will continue to exert downward price pressure on our oxygen therapy products.

 

Our success in the early 1990s drew a significant number of competitors into the home oxygen market. Some of these competitors have substantially greater marketing and financial resources compared with those of the Company. While we believe that our product features and reputation for quality will continue to be competitive advantages, we note that our market is increasingly dominated by price competition. Some of our competitors have successfully introduced lower priced products that do not provide oxygen conserving capabilities comparable to our products. We expect competition to remain keen, with continuing emphasis on price competition for oxygen conservers and therapeutic devices.

 

GENERAL BUSINESS RISKS

 

If we are unable to stay abreast of continuing technological change, our products may become obsolete, resulting in a decline in sales and profitability.

 

The health care industry is characterized by rapid technological change. We have limited internal research and development capabilities. Historically, we have contracted with outside parties to develop new products. Many of our competitors have substantially greater funds and facilities to pursue development of new products and technologies. If we are unable to maintain our technological edge, our product sales will suffer and we may not achieve profitability.

 

Our operating results would be adversely affected if we incur uninsured losses due to product liability claims.

 

The nature of our business subjects us to potential legal actions asserting that we are liable for personal injury or property loss due to alleged defects in our products. Although we maintain product liability insurance in an amount which we believe to be customary for our size, there can be no assurance that the insurance will prove sufficient to cover the costs of defense and/or adverse judgments entered against the Company. To date, we have not experienced any significant losses due to product liability claims. However, given the use of our products by infirm patients, there is a continuing risk that such claims will be asserted against us.

 

Our dependence upon third party suppliers exposes us to the risk that our ability to deliver products may be adversely affected if the suppliers fail to deliver quality components on a timely basis.

 

While we perform most of our manufacturing internally, some of our products depend upon components or processes provided by independent companies. We expect to continue to use outside firms for various processes for the foreseeable future. From time to time, we have experienced problems with the reliability of components produced by third party suppliers. We do not have any long-term supply contracts that are not readily terminable, and we believe there are alternative sources of supply with respect to all the components we acquire from third parties. Nonetheless, any reliability or quality problem encountered with a supplier could disrupt our manufacturing process, thereby delaying our ability to deliver timely product and potentially harming our reputation with our customers.

 

We will continue to implement additional finance and accounting systems, procedures and controls to satisfy new reporting requirements.

 

As a public company, we are required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, including expanded disclosures and accelerated reporting requirements and more complex accounting rules. We are now subject to compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements that may increase our costs and require additional management resources. We may need to continue to implement additional finance and accounting systems, procedures and controls to comply with new reporting requirements. There can be no assurance that we will be able to maintain a favorable assessment as to the adequacy of our internal control reporting. If we are unable to maintain an unqualified report as to the effectiveness of our internal controls over financial reporting, investors could lose confidence in the reliability of our internal controls

over financial reporting and the reliability of our financial statements, which could harm our business and could impact the market price of our common stock.

 

THE SPECIAL MEETING

 

Time, Place and Purpose of the Special Meeting

 

This proxy statement is being furnished to our shareholders as part of the solicitation of proxies by our Board of Directors for use at a special meeting to be held on January 31, 2008, beginning at 10:00 a.m., local time, at our principal executive offices at 21622 Plummer Street, Chatsworth, California 91311. The purpose of the special meeting is for our shareholders to consider and vote upon:

 

 

A copy of the Asset Purchase Agreement is attached to this proxy statement as Annex A. This proxy statement, the notice of the special meeting and the enclosed form of proxy are first being mailed to our shareholders on December 28, 2007.

 

Board Recommendation

 

After considering the current state of the oxygen conserver market, evaluating a wide variety of strategic alternatives and conducting an extensive market test process with the assistance of Ewing Bemiss, an independent investment banking firm, our Board of Directors, has:

 

 

Record Date, Quorum and Voting Power

 

Our Board of Directors has fixed the close of business on December 24, 2007 as the record date for the determination of shareholders entitled to notice of and to vote at the special meeting. Accordingly, only holders of record of shares of our common stock at the close of business on the record date will be entitled to notice of, and to vote at, the special meeting.

 

Each outstanding share of our common stock on the record date entitles its holder to one vote on each matter submitted to shareholders. As of the record date, there were 10,179,759 shares of our common stock entitled to be voted, which were held by approximately 217 shareholders.

 

If a quorum is not present at the meeting, the shareholders present may adjourn the meeting, without notice other than by announcement at the meeting, until a quorum is present or represented. Shares represented by proxies that are marked “ABSTAIN” and “broker non-votes” will be counted as present for the purpose of determining the presence or absence of a quorum at the meeting. A “broker non-vote” occurs when a broker holding shares for a beneficial owner does not vote those shares on a particular proposal because the broker does not have discretionary voting power for that particular item and has not received instructions from the beneficial owner.

 

Required Vote; Abstentions; Broker Non-Votes

 

All holders of record of CHAD’s common stock are entitled to vote on the proposals being submitted to shareholders. For us to complete the Asset Sale, shareholders holding a majority of the shares of our common stock entitled to vote thereon must vote “FOR” the approval of the Asset Sale (Proposal 1). As a result, shares represented at the meeting that are marked “ABSTAIN,” broker non-votes, if any, and shares not represented at the meeting, will have the same effect as votes against this proposal.

 

The approval of the adjournment proposal (Proposal 2) requires that a quorum is present and the affirmative vote of a majority of the shares represented at the special meeting and entitled to vote on the proposal. As a result, shares represented at the meeting that are marked “ABSTAIN” and broker non-votes, if any, will have the same effect as a vote against Proposal 2. Additionally, if you do not complete and return a proxy card, vote by telephone or Internet or do not vote in person, your shares will not be counted towards the establishment of a quorum.

 

Although the American Stock Exchange does not have specific provisions relating to which circumstances a broker can or cannot exercise discretionary authority, we believe that a broker cannot exercise discretionary authority with respect to any of the proposals.

 

Voting by Directors and Executive Officers

 

As of the record date, our directors and executive officers held and are entitled to vote, in the aggregate, 857,633 outstanding shares of our common stock, representing approximately 8.42% of the outstanding shares of our common stock entitled to vote on the proposals. The directors and executive officers have informed us that they intend to vote all of their shares of our common stock “FOR” the approval of the Asset Sale transaction and “FOR” the adjournment proposal.

 

Proxies; Revocation

 

If you vote your shares of our common stock by signing a proxy, or by voting over the Internet or by telephone as indicated on the proxy card, your shares will be voted at the special meeting in accordance with the instructions given. If no instructions are indicated on your signed proxy card, your shares will be voted “FOR” the approval of the Asset Sale and “FOR” the adjournment proposal. The proxies will also be voted FOR or AGAINST such other matters as may properly come before the meeting at the discretion of the proxy holders. The persons appointed in the proxies as proxy holder are officers or directors of CHAD. Our management is not aware that any other matters are to be presented for action at the meeting.

 

You may revoke your proxy at any time before the vote is taken at the special meeting. To revoke your proxy, you must either: (i) advise our Corporate Secretary in writing, (ii) deliver a new proxy dated after the date of the proxy you wish to revoke, (iii) submit another vote over the Internet or by telephone, in each case after the date of the proxy you wish to revoke, or (iv) attend the special meeting and vote your shares in person. Attendance at the special meeting will not by itself constitute revocation of a proxy. If you have instructed your broker to vote your shares, the above-described options for revoking your proxy do not apply and instead you must follow the directions provided by your broker to change these instructions.

 

Shareholders who have questions or requests for assistance in completing and submitting proxy cards should contact Morrow & Co., LLC, our proxy solicitor, at the following telephone numbers: (203) 658-9400 (collect) or (800) 607-0088 (toll-free).

 

Expenses of Proxy Solicitation

 

CHAD will pay the cost of this proxy solicitation, including amounts charged by Morrow & Co., LLC, our proxy solicitor. In addition to soliciting proxies by mail, directors, officers and employees of CHAD may solicit proxies personally and by telephone, facsimile or other electronic means of communication. These persons will not receive additional or special compensation for such solicitation services. In addition, Morrow & Co., LLC will provide solicitation services to us for a fee of approximately $8,500 plus out-of-pocket expenses. CHAD will, upon request, reimburse brokers, banks and other nominees for their expenses in sending proxy materials to their customers who are beneficial owners and obtaining their voting instructions.

 

Shareholder List

 

Either ten days prior to the special meeting or two business days after delivery of this notice, whichever is earlier, a complete list of our shareholders entitled to vote at the special meeting, or any adjournment thereof, will be available for inspection by any of our shareholders during normal business hours at our principal executive offices located at 21622 Plummer Street, Chatsworth, California 91311. In addition, the same list will be available for examination by any of our shareholders at the special meeting.

 

APPROVAL OF PROPOSED ASSET SALE PURSUANT TO
ASSET PURCHASE AGREEMENT

(PROPOSAL 1)

 

We are asking our shareholders to consider and vote upon the Asset Sale as contemplated by the Asset Purchase Agreement, dated as of November 16, 2007, pursuant to which CHAD will sell substantially all of the assets related to its oxygen conserver business to Inovo and Inovo will assume certain liabilities related to the oxygen conserver business.

 

The following is a description of the proposed Asset Sale transaction and the Asset Purchase Agreement. Although we believe that this description covers the material terms of the transaction, the description may not contain all of the information that is important to you. We encourage you to read carefully this entire proxy statement, including the copy of the Asset Purchase Agreement attached to this proxy statement as Annex A, for a more complete understanding of the transaction. The following description is subject to, and is qualified in its entirety by reference to, the Asset Purchase Agreement.

 

Background of the Asset Sale

 

The terms and conditions of the Asset Purchase Agreement and the Asset Sale are the result of arm’s length negotiations between our representatives and the representatives of Inovo. Set forth below is a summary of the background of these negotiations.

 

Since 2004, the market for our core oxygen therapy products has deteriorated steadily. There has been a consolidation trend among home health care dealers, our primary customers. This increasing concentration, together with cost cutting efforts implemented under government reimbursement policies, has resulted in sustained price pressure on our products. Moreover, a series of actual and proposed changes relating to the level of reimbursement for home oxygen therapy by Medicare, Medicaid and other third-party health insurers, and the methodology according to which the level and timing of reimbursement would be determined in the future, has caused many customers to reduce or defer their purchases. During this same period, our management believed that our sleep disorder technology had significant commercial potential that could only be realized if we could attract sufficient capital to complete the development and marketing of the sleep disorder products or form an alliance with another company with substantial capital resources and distribution capabilities.

 

On August 11, 2005, the investment banking firm of Ewing Bemiss outlined to the Board of Directors the potential advantages of our strategic options, including the raising of additional capital and the sale of the Company as a whole or in parts.

 

On October 1, 2005, our Board of Directors, after interviewing several investment banks, engaged Ewing Bemiss to assist us in exploring our strategic options, including the possible sale of the Company. Ewing Bemiss was selected based upon the Board’s conclusion that its extensive experience in the home health care market and its commitment of senior investment bankers to our engagement made it an appropriate choice to advise the Company.

 

On October 27, 2005, the Board of Directors authorized Ewing Bemiss to initiate contact with potential buyers of the entire Company, our oxygen therapy business or our sleep disorder business. During November and early December 2005, Ewing Bemiss contacted 22 parties to determine their interest in the acquisition of the Company or of our oxygen therapy or sleep disorder business.

In December 2005, we entered into confidential merger discussions with a major provider of healthcare products and services. Detailed discussions and negotiations with this potential buyer continued through August 8, 2006, but were ultimately unsuccessful. Following the termination of these negotiations, the Board of Directors instructed Ewing Bemiss to go back to other parties that had expressed preliminary interest in the possible acquisition of the Company or its assets to determine whether other merger or sale options were available to the Company.

 

During September 2006, Ewing Bemiss contacted six parties that had expressed interest in the acquisition of the Company or of either our oxygen therapy or sleep disorder business, and determined that none of these parties was prepared to pursue a merger or acquisition transaction at that time.

 

Throughout the remainder of 2006 and the first quarter of 2007, Ewing Bemiss maintained contact with a number of the leading manufacturers of oxygen therapy devices and sleep diagnostic and therapeutic devices and with a number of providers of home respiratory therapy and/or sleep diagnostic and therapeutic services in order to monitor their potential interest in any strategic transaction or joint venture with the Company. On February 1, 2007, Samuel Bemiss, a principal of Ewing, Bemiss, briefed our Board of Directors on the status of such potential opportunities.

 

A number of potential buyers executed confidentiality letters with us and initiated due diligence but, ultimately, each of these parties declined to proceed with a strategic transaction involving the Company.

 

On May 23, 2007, Mr. Bemiss received a call from Mr. Jack Gary of Raymond James Financial Inc., in which Mr. Gary indicated that Inovo might have an interest in either a merger with us or the acquisition of our oxygen therapy business. Mr. Gary provided an introduction to Mr. Michael Mulroy, Inovo’s Vice President of Finance. Mr. Bemiss initiated discussions with Mr. Mulroy, and on June 11, Inovo executed a confidentiality letter with the Company.

 

On June 12, 2007, the Board of Directors approved the execution of a revised engagement letter with Ewing Bemiss & Co. and instructed Mr. Bemiss to continue to explore our options with respect to a merger, an asset sale or a joint development and distribution venture involving the sleep disorder business.

 

On June 14, 2007, Mr. Mulroy and Inovo’s Chief Executive Officer, Mr. George Harris, met with our senior management in the Company’s offices in Chatsworth, California to begin a formal due diligence process.

 

Throughout the remainder of June, July and early August, Mr. Bemiss and our management continued to hold confidential discussions with Inovo. During this time frame, Mr. Bemiss also pursued discussions with four other companies, each of which had expressed some interest in acquiring assets of the Company.

 

On August 17, 2007, the Board of Directors held a teleconference meeting and Mr. Bemiss reported to the Board on the status of discussions with Inovo and the four other companies. Subsequent to the meeting, Mr. Michael Mulroy, Chief Financial Officer of Inovo, outlined to Mr. Bemiss by telephone a preliminary proposal to acquire our oxygen therapy business for a price in the range of $5,000,000 to $7,000,000.

 

On August 22, 2007, Mr. Mulroy delivered to Mr. Bemiss Inovo’s initial Letter of Intent (“LOI”) to acquire the oxygen therapy business for $5,000,000, subject to working capital adjustments. On August 25, 2007, the Board of Directors held a teleconference meeting and Mr. Bemiss advised the Board of the LOI received from Inovo. He also discussed with the Board an indication of interest received from another company to acquire the sleep disorder assets of the Company. The Board of Directors discussed the LOI received from Inovo and agreed to continue negotiations with Inovo. These matters, and the status of negotiations with Inovo, were further discussed at meetings of the Board of Directors held via teleconference on August 31 and September 7, 2007.

 

During early September, Messrs. Bemiss, Mulroy and Harris held numerous discussions concerning the terms of the Inovo LOI and, on September 26, 2007, Mr. Harris delivered to Mr. Bemiss a revised LOI, proposing to buy our oxygen therapy business for $6,000,000, subject to working capital adjustments. Mr. Bemiss also continued discussions with the four other companies that had expressed an interest in acquiring a portion of our assets. However, by the end of September, it had become clear that none of these other companies was prepared to move forward on terms that were acceptable to us, nor had any companies been identified that were prepared to acquire all of CHAD.

On September 27, 2007, the Board of Directors held a meeting via teleconference to discuss the revised LOI received from Inovo. Mr. Bemiss participated in the meeting. At the meeting the Board discussed certain aspects of the proposed Asset Sale, including (i) the likely time schedule for due diligence, negotiation, documentation and closing of the proposed transaction; (ii) regulatory requirements and stockholder notice and vote requirements; (iii) the tax consequences of the proposed transaction; and (iv) the terms of a “no shop” agreement and a breakup fee proposed by Inovo. The Board of Directors then authorized management to enter into an LOI with Inovo subject to certain revisions but on terms substantially similar to the revised draft provided by Mr. Mulroy on September 26. Accordingly, on October 5, 2007, we entered into an LOI with Inovo, which provided, among other things, that Inovo would acquire our oxygen therapy business for $6 Million in cash subject to working capital adjustments. Pursuant to the LOI, Inovo would acquire both our oxygen conserver assets and our transfilling assets. The LOI also provided that we would not, subject to certain fiduciary obligations of the Board of Directors, solicit, initiate, or engage in discussions or negotiations with any third party regarding a possible acquisition of the Company or its assets. The LOI and the exclusive negotiation period were scheduled to expire on October 31, 2007. On October 10, 2007, the Board of Directors met via teleconference to review the terms of the executed LOI and to discuss issues related to implementation of the proposed Asset Sale.

 

Throughout October and early November, there were frequent discussions and negotiations between Company management, Inovo management, Mr. Bemiss and lawyers and advisors to both parties regarding the Asset Purchase Agreement and related agreements. Our Board of Directors was updated on the status of such negotiations at a meeting held via teleconference on October 19, 2007 and a meeting held in Chatsworth, California on October 23, 2007. On October 31, 2007, the parties extended the LOI and exclusive negotiation period through November 15, 2007.

 

On November 12, 2007, the Board of Directors held a special meeting in Chatsworth, California, to discuss the terms of the proposed transaction with Inovo as set forth in a draft Asset Purchase Agreement which had been distributed to the Board. Representatives of Ewing Bemiss, our financial advisers, and Morrison & Foerster LLP, our legal advisers, participated in the meeting. Mr. Bemiss reviewed with the Board of Directors the efforts undertaken by Ewing Bemiss to canvass the market for an acquirer of the Company or its assets. He also reviewed recent economic trends in the industry and the status of continuing uncertainty as to reimbursement policies applicable to oxygen therapy equipment used in a home health care setting. He then reviewed in detail the principal business terms of the draft Asset Purchase Agreement and related documents pertaining to the proposed Asset Sale. Mr. Bemiss discussed, among other things, the potential purchase price adjustments set forth in the Asset Purchase Agreement. Mr. Bemiss next reviewed the financial analyses undertaken by Ewing Bemiss with respect to the proposed Asset Sale. A representative of Morrison & Foerster LLP then reviewed with the Board of Directors the legal terms and conditions contained in the draft Asset Purchase Agreement. The Board of Directors adjourned the meeting with plans to reconvene on the morning of November 14, 2007, to take a final vote on the proposed Asset Sale.

 

Late in the day on November 13, 2007, we were advised by the licensor of technology used in the Company’s transfilling business, that the licensor would only consent to an assignment of our rights in such technology to Inovo subject to certain material conditions. Inovo advised us that such conditions were not acceptable to it. We immediately commenced further discussions with Inovo regarding the possibility of selling only our oxygen conserver business and not the transfilling assets which had been part of the original proposed transaction. That evening and the following morning, we engaged in negotiations with Inovo regarding the price Inovo would be willing to pay for the oxygen conserver business.

 

On the morning of November 14, 2007, the Board of Directors met via teleconference and was briefed on the licensor’s refusal to consent on terms acceptable to Inovo and the pending discussions with Inovo regarding a restructured deal. The Board of Directors advised management of the terms it would accept for a sale of the oxygen conserver business. Following the Board of Directors meeting, our management reached an agreement with Inovo to sell the oxygen conserver business for $5,250,000 in cash, subject to working capital adjustments.

 

The Board of Directors reconvened its meeting via teleconference on the afternoon of November 14. The Board was advised of Inovo’s offer to buy the oxygen conserver business for $5,250,000 in cash, subject to working capital adjustments. The Board was further advised that, other than conforming changes to reflect the assets to be

sold, the terms and conditions of the Asset Sale were substantially the same as those set forth in the Asset Purchase Agreement reviewed by the Board on November 12. Following a discussion, our Board of Directors unanimously approved the Asset Sale for $5,250,000 in cash, subject to working capital adjustments, pursuant to the terms and conditions set forth in the Asset Purchase Agreement.

 

Recommendation of CHAD’s Board of Directors; Reasons for the Asset Sale Transaction

 

The Board of Directors believes that the Asset Sale is fair to, and in the best interests of the Company and its shareholders and the Board of Directors has unanimously approved the Asset Purchase Agreement and the Asset Sale. The Board believes that the Asset Sale will be beneficial to the Company and its shareholders for several reasons, including the following:

 

 

In addition to the factors set forth above, in the course of its deliberations concerning the Asset Sale, the Board of Directors consulted with the Company’s legal and financial advisors as well as our management team, and reviewed a number of other factors relevant to the Asset Sale, including:

 

 

 

The Board of Directors also considered a number of potentially negative factors in its deliberations concerning the Asset Sale, including;

 

 

The Board of Directors concluded that, while these risks were not insignificant, they were outweighed by the potential benefits of the Asset Sale.

 

The foregoing discussion of information and factors considered by our Board of Directors is not intended to be all-inclusive. In view of the wide variety of factors considered by our Board of Directors, the Board did not find it practicable to quantify or otherwise assign relative weight to the specific factors considered. However, after taking into account all of the factors set forth above, the Board of Directors unanimously agreed that the Asset Purchase Agreement and the consummation of the Asset Sale were fair to, and in the best interests of, the Company and its shareholders and that we should proceed with the Asset Sale.

 

Interests of CHAD’s Executive Officers

 

When considering whether to approve the Asset Sale, you should be aware that our executive officers may be deemed to have an interest in the Asset Sale in addition to their interests as CHAD shareholders, that may be different from, or conflict with, your interests as a CHAD shareholder.

 

In order to enhance our near-term liquidity, on December 19, 2007, our Board of Directors approved a credit facility with Mr. Earl Yager and Mr. Thomas Jones, our Chief Executive Officer and our Chairman of the Board, respectively (the “Credit Facility”). Pursuant to the terms of the Credit Facility, we may draw an aggregate of $1,000,000, subject to certain conditions. We made an initial draw down in the principal amount of $300,000.

 

Notes issued under the Credit Facility will 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 Asset Sale or (ii) August 30, 2010. The notes will be secured by the assets of the Company, but the security interest will be subordinated to the security interest of Calliope Capital Corporation discussed below. In connection with the Credit Facility, Mr. Yager and Mr. Jones each will receive warrants to purchase our common stock at a price per share equal to 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 (“Exercise Price”). 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 we may make under the Credit Facility.

 

The Board of Directors appointed two independent members of the Board to evaluate and negotiate the terms of the Credit Facility. Neither Mr. Yager nor Mr. Jones participated in the meeting of the Board of Directors which approved the Credit Facility. In its evaluation of the Credit Facility, the independent members of the Board of Directors considered the terms of other potential funding sources and determined that the Credit Facility was more favorable to the Company and its shareholders than the terms proposed by other sources of funding. The Board of Directors also consulted with financial and legal advisers and considered the Company’s current financial condition, its recent operating performance and market conditions for distressed borrowers in its evaluation of the Credit Facility.

We expect that several of our executive officers will be terminated following the Asset Sale and will be entitled to severance payments as set forth below.

 

 

In addition, we have entered into change in control severance agreements with each of our executive officers. The severance agreements were entered into under a Severance and Change in Control Policy that we adopted in 1997 and have been consistently used for substantially all of our employees, including our executive officers. The severance agreements provide for payments if the employee is terminated within two years of a change in control of the Company. The amount payable varies by position; our executive officers would be entitled to a severance payment equal to two times their annual salary if they are terminated within two years of a change in control of the Company. Our Board of Directors has determined that the Asset Sale will not, in and of itself, constitute a change in control. However, if, in addition to the Asset Sale, we sell all or a substantial portion of our remaining assets, or if we sell the Company, then severance payments could be triggered for our executive officers. The table below sets forth information about possible additional severance payments that could become payable to our executive officers in the future.

 

 

Regulatory Approvals

 

There are no federal or state regulatory requirements with which we must comply, nor are we required to obtain any federal or state approval, in order to consummate the Asset Sale.

 

Appraisal Rights

 

CHAD shareholders will have no appraisal rights under California law in connection with the Asset Sale.

 

Inovo Inc. is a privately held Florida corporation based in Naples, Florida. It is a leading manufacturer of oxygen regulators and conserving devices, serving the home healthcare, emergency medical services and hospital markets.

 

The Transaction

 

At the closing of the Asset Sale, we will transfer and convey to Inovo substantially all of the assets of our oxygen conserver business and Inovo will assume specified liabilities of that business. The oxygen conserver business includes all of the oxygen conservers which we currently market, including the OXYMATIC, OXYMIZER, LOTUS, BONSAI, SEQUOIA, CYPRESS and SAGE product lines. It also includes accessories such as carrying bags and tubing.

 

Purchased Assets

 

The purchased assets include:

 

 

Excluded Assets

 

Inovo will not acquire the assets related to our transfilling business (the TOTAL O ₂ , OMNI-2 and OMNI-5 product lines) nor will it acquire the assets related to our products under development for the sleep disorder market (the “Excluded Assets”). The following assets and properties will not be acquired by Inovo:

 

 

Assumed Liabilities

 

Upon the terms and subject to the conditions of the Asset Purchase Agreement, Inovo has agreed, effective at the time of the closing, to assume only the following liabilities, which we refer to as assumed liabilities:

 

 

Retained Liabilities

 

Other than the assumed liabilities, all of our other liabilities and obligations will be retained by us, which liabilities and obligations we refer to as retained liabilities, and include:

 

 

Assignment of Contracts and Rights

 

In the event that the conveyance of a purchased asset would constitute a breach of our obligations related to such purchased asset or in any way adversely affect our rights or Inovo’s rights without the consent of third parties, we have agreed to obtain the consent of appropriate parties for the conveyance.

 

Purchase Price

 

Inovo has agreed to pay $5,250,000 in cash for the purchased assets, which amount we refer to as the purchase price. The purchase price is subject to adjustment as follows: the purchase price may be adjusted on a dollar-for-dollar basis up,

to a ceiling of $250,000 or down, with no floor, by subtracting CHAD’s interim working capital from the closing working capital. The closing working capital is calculated on the same basis and applying the same accounting practices and policies that were used in preparing the interim balance sheets. At closing, Inovo is required to deliver to us $4,900,000 in cash. The remaining $350,000 of the purchase price will be deposited into an escrow account pursuant to the Escrow Agreement. Following the closing, Inovo shall calculate the working capital of the oxygen conserver business as of the closing date. We may accept Inovo’s calculation or we may challenge it. If an agreement cannot be reached between us and Inovo with respect to the working capital as of the closing date, then the matter will be submitted for final determination to an independent accounting firm, Hill, Barth & King, LLP. Once the closing date working capital has been finally determined, an adjusting payment will be made by one party to the other to reflect changes in the working capital from September 30, 2007 to the closing date. If a payment is due Inovo based on such final calculation, the first $250,000 of such payment shall be taken from the escrow account. Any remaining funds will remain in escrow until the earlier of 180 days after the closing or 150 days after the closing in the event we enter into a subsequent transaction to sell our sleep disorder business.

 

Closing

 

If the Asset Sale is approved and adopted by our shareholders, the closing will take place as soon as possible after the special shareholder meeting. We are not aware of any regulatory requirements which would delay the closing.

 

Representations and Warranties

 

The Asset Purchase Agreement contains certain representations and warranties of CHAD and Inovo. We have made representations and warranties relating to, among other things:

 

 

 

The Asset Purchase Agreement also contains customary representations and warranties made by Inovo, which relate to, among other things:

 

 

These representations and warranties have been made solely for the benefit of the parties to the Asset Purchase Agreement and are not intended to be relied on by any other person. You should rely on the disclosure in this proxy statement rather than the representations and warranties in the Asset Purchase Agreement.

 

In addition, these representations and warranties are qualified by specific disclosures made to the other parties in connection with the Asset Purchase Agreement, are subject to the materiality standards contained in the Asset Purchase Agreement which may differ from what may be viewed as material by investors and were made only as of the date of the Asset Purchase Agreement or such other date as is specified in the Asset Purchase Agreement.

 

Conduct of Our Business Pending the Closing

 

During the period between the signing of the Asset Purchase Agreement and the closing of the Asset Sale, we have agreed, subject to certain exceptions, that we will conduct the oxygen conserver business only in the ordinary course of business and in a manner consistent with past practice, and use commercially reasonable efforts to maintain and preserve intact our business organization, our licenses and permits, the services of our key employees, and the goodwill of those having business relationships with us. In addition, we have also agreed that during the same time period, subject to certain exceptions or unless Inovo gives its prior written consent, we will not:

 

 

Non-Compete

 

We have agreed, for a period of five (5) full years after the closing date, not to engage in any business that competes with the oxygen conserver business or engage in the business of marketing, distributing and selling devices related to the oxygen therapy business, provided however, that we may continue to develop, manufacture, distribute, and market products that are primarily designed for diagnosis and treatment of sleep disorders, some of which may have collateral therapeutic benefits for patients requiring supplemental oxygen, and we may continue to develop, manufacture, distribute and market our transfilling products. Further, we have agreed, for a period of five (5) full years after the closing date, not to directly or indirectly attempt or cause or induce any customer, supplier, licensee, licensor, franchisee, employee consultant or other business relation of Inovo or CHAD to in any way interfere with its relationship with Inovo. We may also not hire, retain, or attempt to hire or retain any employee of Inovo or in anyway interfere with the relationship between Inovo and any of its employees or independent contractors.

 

No Solicitation of Competing Offers; Right to Consider Superior Proposal

 

We have agreed not to, and we will not authorize or permit any of our officers, directors, employees, financial advisors, attorneys, accountants or other advisors or representatives retained by us to, directly or indirectly, solicit, initiate, encourage, or, except to the extent necessary for our Board of Directors to comply with its fiduciary duties as advised by counsel, entertain, any inquiry, offer or proposal relating to the transfer or acquisition by purchase, merger, lease, recapitalization, or otherwise of any of our capital stock, the oxygen conserver business or any combination of the foregoing (a “Competing Transaction”). We will notify Inovo within twenty-four hours of receipt or awareness of a Competing Transaction.

 

However, if any of our officers, directors, employees, financial advisors, attorneys, accountants or other advisors or representatives retained by us, receives an unsolicited offer or proposal providing for the acquisition of us, the oxygen conserver business or the assets relating to the oxygen conserver business, or a similar transaction (a “Competing Offer”), and our Board of Directors determines in good faith, after consulting with outside counsel, that responding to such Competing Offer is necessary in order for the Board to comply with its fiduciary duties to the our shareholders, then we and our representatives may (i) participate in discussions and negotiations with the person making the Competing Offer, and (ii) furnish information with respect to us and our oxygen conserver business to such person, provided that (x) the Competing Offer was not made in violation of the Asset Purchase Agreement, (y) we entered into a customary non-disclosure agreement with such person, and (z) we do not enter into any agreement with such person providing for exclusive negotiations.

 

Notwithstanding the foregoing, we are free to take all reasonable and necessary steps to pursue the sale of any of (i) our assets not associated with the oxygen conserver business, (ii) our sleep disorder assets, (iii) our transfilling assets and (iv) our capital stock, so long as any such sale of capital stock will not interfere with the Asset Sale.

 

Our Board of Directors may, in response to a Competing Offer that does not result from any breach of the Asset Purchase Agreement, cause CHAD to terminate the Asset Purchase Agreement in connection with CHAD entering into a definitive agreement with respect to a Competing Offer. In such situation, or if the Asset Purchase Agreement is terminated for any reason other than Inovo’s breach and, within 12 months thereafter, we complete a Competing Transaction, CHAD will be required to pay Inovo a fee of $200,000. See “The Asset Purchase Agreement — Fees and Expenses.”

 

Employee Benefits

 

On the closing date, Inovo will offer employment to certain employees who we refer to as transferred employees. Any such offers will be subject to final employment interviews, compliance with Inovo’s employment criteria, and agreement on the terms of employment between Inovo and each transferred employee. We have agreed not to take any action that would interfere or compete with Inovo’s effort to hire transferred employees.

 

Except as otherwise provided in the Asset Purchase Agreement, we will retain all obligations and liabilities under our employee benefit plans with respect to our employees who are not hired by Inovo. In addition, all transferred employees will become fully vested in their accrued benefits under our retirement plans as of the closing

date, and we will amend such plans if necessary to achieve this result. We will retain all liabilities and obligations with respect to benefits accrued as of the closing date by transferred employees under our employee benefit plans.

 

Conditions to the Asset Sale

 

The obligations of the parties to complete the Asset Sale are subject to certain conditions, including:

 

 

The obligation of Inovo to complete the Asset Sale is subject to certain additional conditions, including:

 

 

Our obligation to complete the Asset Sale is subject to certain additional conditions, including:

 

 

Survival; Indemnification

 

The representations and warranties of each of the parties to the Asset Purchase Agreement will survive the closing until the second anniversary of the closing date or for the shorter period explicitly specified therein, except

that for such other representations and warranties as to which a claim may be made at any time, breaches thereof will survive indefinitely or until the latest date permitted by law.

 

We have agreed to indemnify Inovo for any loss, liability, claim, damage, expense, diminuition of value, including all reasonable expenses of investigation and reasonable attorneys’ fees, in connection with any action, suit or proceeding involving a third-party claim or a claim solely between us and Inovo arising out of:

 

 

Inovo has agreed to indemnify us for any loss, liability, claim, damage, expense, diminuition of value, including all reasonable expenses of investigation and reasonable attorneys’ fees, in connection with any action, suit or proceeding involving a third-party claim or a claim solely between us and Inovo arising out of:

 

 

Termination of the Purchase Agreement

 

The parties to the Asset Purchase Agreement may terminate the agreement at any time without completing the Asset Sale under certain circumstances, including:

 

 

 

 

 

 

 

 

Transition Services Agreement

 

If we enter into the Asset Sale, then we will provide certain transition services to Inovo for a period that will end no later than June 15, 2008 (unless earlier terminated or extended by the mutual written agreement of the parties). During the transition period, we will continue to manufacture oxygen conservers in our Chatsworth facility for sale by Inovo and provide certain other services to assist Inovo with the operation of the oxygen conserver business. Services to be provided by CHAD will include all activities ordinarily associated with the manufacture and sale of oxygen conserver business, under Inovo’s oversight. Inovo will be responsible for the payment of certain fees relating to the operation of the oxygen conserver business, the actual wages, salaries, incentive compensation for three sales personnel associated with the oxygen conserver business, and employment benefits for the transition employees, including any employees hired on a temporary basis to assist with the transition. Inovo will also be required to pay CHAD a daily fee for the costs and expenses incurred in maintaining and operating the Chatsworth, California, facility during such time that Inovo’s equipment remains in that facility and cover certain other out of pocket expenses incurred by CHAD.

 

Furthermore, Inovo will indemnify CHAD and its representatives, directors, officers, agents, employees, successors, and assigns from and against any and all losses, liabilities, damages, and deficiencies (including costs of defense and attorneys’ fees), which are not covered by CHAD’s insurance, that such persons or parties may suffer, sustain, incur, or become subject to as a result of performing any services under the Transition Services Agreement in accordance with specific written instructions, authorizations, or approvals provided by Inovo or its representatives to CHAD or its employees or agents.

 

Inovo will transfer the oxygen conserver operations to its facilities in Naples, Florida no later than June 15, 2008.

 

Fees and Expenses

 

Generally, the parties to the Asset Purchase Agreement are responsible for their own transaction expenses if the transaction is completed or if either party terminates the Asset Purchase Agreement for any reason allowed under the Asset Purchase Agreement.

 

We have agreed to pay Inovo a termination fee of $200,000 if (i) we consummate a Competing Transaction within 12 months after the Asset Purchase Agreement is terminated for any reason other than a breach by Inovo of its obligations, (ii) our Board of Directors fails to recommend approval of the Asset Sale, (iii) we terminate the Asset Purchase Agreement prior to the shareholder meeting as a result of receiving a Competing Bid or (iv) we fail to honor our obligations not to solicit a Competing Bid.

 

Amendment and Waiver

 

The Asset Purchase Agreement may be amended or waived if, but only if, such amendment or waiver is in writing and is signed, in the case of an amendment, by each party to the Asset Purchase Agreement, or in the case of a waiver, by the party against whom the waiver is to be effective.

 

Material U.S. Federal Income Tax Consequences of the Asset Sale Transaction

 

The following is a general summary of the material United States federal income tax consequences of the Asset Sale. This summary is based on the Internal Revenue Code, existing, temporary and proposed U.S. Treasury regulations, and published rulings, guidance, and court decisions, all as currently in effect on the date hereof, and all of which are subject to change by legislative, judicial, or administrative action, possibly with retroactive effect.

 

While this summary addresses the material United States federal income tax consequences of the Asset Sale, neither state, foreign nor local tax consequences of the Asset Sale are discussed. Further, this summary is not a complete description of all of the federal income tax consequences that may be relevant to the Asset Sale. Our shareholders should consult with their own tax advisers for advice regarding the Untied States federal, state, local and other tax consequences of the Asset Sale.

 

The Asset Sale will be a taxable transaction to the Company, and we generally will recognize gain or loss based on the difference between the consideration received in respect of the Asset Sale and our adjusted tax basis in the assets transferred pursuant thereto. The Asset Sale is expected to result in a taxable loss to the Company.

 

The Asset Sale is a corporate action of the Company. Therefore, the Asset Sale will not be a taxable event for federal income tax purposes to our shareholders.

 

THE ASSET SALE TRANSACTION ADJOURNMENT PROPOSAL

 

(Proposal 2)

 

We are asking our shareholders to authorize the holder of the proxy solicited by our Board of Directors to vote in favor of adjourning the special meeting to a future date in order to enable our Board of Directors to solicit additional proxies, if necessary, to obtain approval of the Asset Sale by a majority of our outstanding shares.

 

If at the special meeting the number of shares of our common stock voting in favor of the Asset Sale transaction is insufficient to approve such proposal, the chairperson of the meeting may move to adjourn the special meeting to enable us to solicit additional proxies in favor of the Asset Sale. If such a proposal is made at the meeting by the chairperson, the proxy holder will only be able to vote in favor of this proposal the shares for which it has received a valid proxy indicating that it has authority to vote in favor of this proposal to adjourn the meeting. The authority granted to the holder of the proxy pursuant to this proposal will be limited and will not authorize the holder to vote in favor of adjourning the meeting with respect to any proposals other than the Asset Sale as contemplated by the Asset Purchase Agreement.

 

Required Vote

 

The approval of this Proposal 2 requires that a quorum is present and the affirmative vote of a majority of the shares represented at the special meeting and entitled to vote on the proposal. As a result, shares represented at the meeting that are marked “ABSTAIN” and broker non-votes, if any, will have the same effect as a vote against the proposal.

 

Under the California Corporations Code, a corporation can convene a meeting of shareholders, take a vote on certain of the proposals presented at the meeting and, assuming the adjournment proposal or proposals receive the necessary number of favorable votes, adjourn the meeting with respect to such proposal or proposals to allow for the additional solicitation of proxies.

 

If we were to adjourn the special meeting in order to solicit additional proxies, we expect to continue to use the original proxy card for such solicitation.

 

Recommendation of Our Board of Directors

 

to the beneficiary after 36 months. Consequently, with the incentive to operate efficiently, inexpensive concentrators have grown in popularity because of their low cost and less frequent servicing requirements. At the same time, interest in oxygen conserving devices, which can extend the life of oxygen supplies and reduce service calls by providers, has heightened. There is also a separate fixed allowance from Medicare for patients who need to be mobile and therefore require portable oxygen systems.

 

In November 2003 Congress enacted the Medicare Improvement and Modernization Act, which had and will continue to impact reimbursement for home oxygen over the next several years. The new legislation will result in continued pressure on home care providers to reduce the cost of providing home oxygen services as it mandated that the monthly fee that home care providers receive will be subject to competitive bidding. This will first be implemented in ten (10) major markets on April 1, 2008. In January of 2007, Medicare implemented a new reimbursement category for transfilling systems, like the Company’s TOTAL O ₂ Delivery System, which may improve the marketability of these devices.

 

While these cost pressures have intensified, mobility has increased in importance as the treatment of pulmonary patients has moved away from hospitals and into home care. Also, the American Lung Association has advised that, to reduce and control symptoms, pulmonary patients should live a healthy lifestyle that includes exercise. Maintaining quality of life and compliance with prescribed exercise programs require that the patient be as mobile as possible, thereby increasing the demand for portable oxygen equipment.

 

CHAD’s Products

 

Since its inception, the Company has recognized the need for more efficient oxygen delivery systems and has pursued the development and marketing of devices that are designed to conserve oxygen. The benefits of such improvements include substantial cost savings for the home care provider, as well as increased mobility for ambulatory patients who require portable oxygen supplies. These devices extend the life of oxygen supplies and make possible more compact and longer lasting portable systems, thereby improving the quality of life for home oxygen patients.

 

OXYMIZER ^® and OXYMIZER Pendant Oxygen Conserving Devices .   In June 1983 the Company began marketing its first product, the OXYMIZER disposable oxygen conserving device, a unique, patented, disposable device developed to provide up to four-to-one (4:1) savings of oxygen as compared to continuous flow systems when used with any oxygen supply source.

 

The OXYMIZER device contains a collapsible reservoir that captures incoming oxygen delivered during expiration and prevents its waste. The oxygen captured in this reservoir is then inhaled by the patient during the first instant of his next inspiration. Thus the OXYMIZER device both conserves oxygen and provides the patient with an extra rich supply of oxygen at the beginning of the inhalation period when it can be most effectively utilized.

 

Extensive clinical testing and trials over the past 23 years have repeatedly demonstrated that patients using the OXYMIZER device are able to achieve equivalent blood oxygenation levels while using significantly less oxygen. There have been more than 32 clinical evaluations from institutions worldwide that have confirmed the efficacy and oxygen savings of the OXYMIZER devices.

 

The greater efficiency provided by these devices over standard oxygen delivery systems also permits home health care patients to achieve greater mobility by enabling them to use smaller portable cylinders or by obtaining two (2) to four (4) times the life from standard sized portable cylinders.

 

For home oxygen providers, the disposable OXYMIZER devices afford the cost advantages of oxygen conservation without capital investment in expensive equipment. In addition, the OXYMIZER devices can be utilized to achieve higher flow setting equivalencies for standard oxygen concentrators.

 

In hospitals, the OXYMIZER devices are used for maintenance of certain patients requiring higher flow levels of oxygen without having to resort to uncomfortable oxygen masks.

 

The Company has pursued a marketing strategy that emphasizes the cost savings, efficiencies, and level of patient comfort associated with the use of the OXYMIZER devices. See “Marketing” and “Competition.”

The OXYMIZER Pendant device is similar to the OXYMIZER device except that its reservoir is located in a “pendant” that hangs over the patient’s chest rather than under the nose. The OXYMIZER Pendant has a more traditional appearance than the OXYMIZER. The Company began marketing the OXYMIZER Pendant in August 1984.

 

OXYMATIC ^® Electronic Oxygen Conservers .   The Company began marketing the OXYMATIC conserver in March 1986. This product is a small electronic device designed for use with portable oxygen systems. The OXYMATIC conserver electronically senses the optimal moment in the breathing cycle for delivery of oxygen and at that moment releases a very brief pulse of oxygen to the patient. The OXYMATIC conserver concentrates the administration of oxygen during the first one-third (1/3) of the inhalation phase, when oxygen is most efficiently utilized. There have been at least 12 controlled clinical trials and studies of patient groups using the OXYMATIC conserver, all of which have confirmed its efficacy and efficiency.

 

In July 2000 the Company introduced the first of the OXYMATIC 400 series of conservers. Additional models were added to this line in January and March of 2001. This new line of conservers was designed to capitalize on the proven reliability and efficiency of the Company’s previous models. In addition, features and options were added to create state-of-the-art conservers that would give home care providers a wide choice of products to service their patients’ individual needs and preferences. These new conservers include a built-in regulator and expanded flow rates that provide average savings of five-to-one (5:1) over continuous flow oxygen systems.

 

In November 2001 the Company introduced the SEQUOIA OXYMATIC line of conservers. These conservers utilize the same electronic features as the OXYMATIC 400 series conservers but do not contain a built-in regulator.

 

LOTUS Electronic Oxygen Conservers.   The Company received clearance from the Food and Drug Administration (FDA) to market the LOTUS Electronic Oxygen Conserver in October 2004 and began shipment of the device in November 2005. The LOTUS weighs less than one (1) pound and is offered with or without a breath-sensing alarm. It also offers additional liter flow settings and an extended battery life of up to four (4) months of normal usage on two (2) AA-size batteries.

 

CYPRESS OXYPneumatic ^® Conservers .   In July 2002 the Company began marketing the CYPRESS pneumatic conserver, which allowed the Company to compete in the pneumatic segment of the conserver market for the first time. This device incorporates no electronic parts, thus eliminating the need for batteries. It is lightweight, small and allows the use of a standard, single-lumen cannula, unlike many other pneumatic conservers that require special cannulas. The CYPRESS conserver provides flow rates from one (1) to six (6) liters per minute and oxygen savings greater than three-to-one (3:1) over continuous flow oxygen.

 

The OXYMATIC electronic and CYPRESS pneumatic conservers extend the length of time the contents of the cylinders will last over continuous flow oxygen systems. They provide ambulatory patients with greater mobility and less weight. The Company believes these systems offer a superior alternative to commonly used liquid oxygen systems for mobile patients and are more cost effective for home care providers to supply.

 

BONSAI Pneumatic Conservers .   In April 2007 the Company announced the new BONSAI pneumatic conserver. The BONSAI conserver incorporates a number of new features, including lightweight design (less than 10 ounces), conserving ratios of up to six-to-one (6:1), eight (8) settings and an adjustable continuous flow feature. The Company received FDA Clearance to market this new device in May 2007 and began shipments in the summer of 2007.

 

SAGE-Oxygen Therapeutic Device .   In May 2004 the Company received clearance from the FDA to market its new SAGE Oxygen Therapeutic Device. The SAGE device uses 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. The SAGE device combines the industry’s first truly dynamic, patented delivery technology with the proven oxygen sensor technology in the Company’s OXYMATIC 400 series conserver. As a result, the device addresses the common problem of oxygen desaturation, which causes a patient to feel weak and out of breath when activity increases, yet it still maximizes patient ambulatory capability.

 

Sales of electronic and pneumatic conservers, therapeutic devices and related equipment and accessories accounted for 91%, 89% and 90% of the Company’s sales in 2007, 2006 and 2005 respectively.

OXYCOIL ^® Coiled Oxygen Tubing .   In January 1986 the Company began marketing the OXYCOIL coiled oxygen tubing, a device which replaces the standard supply tubing for the OXYMIZER devices, the OXYMATIC conservers or conventional nasal cannulas. The OXYCOIL tubing is a convenience and a safety device that can be used with any oxygen system to help keep the supply tubing out of the patient’s way, thus minimizing the tripping and tangling problems associated with standard supply tubing.

 

TOTAL O ₂ ^® Delivery System .   In January 1998 the Company began marketing the TOTAL O ₂ Delivery System. This system provides stationary oxygen for patients at home, portable oxygen including an oxygen conserving device for ambulation, and a safe and efficient mechanism for filling portable oxygen cylinders. The TOTAL O ₂ Delivery System was designed to provide home care providers with a more cost effective means to provide home oxygen services while at the same time providing the patients with a higher quality of service. This can be accomplished as the home care provider will no longer be required to make regular monthly service calls to deliver full portable cylinders, and the patient will no longer be dependent on the provider for those deliveries to obtain full cylinders.

 

Initial sales of the TOTAL O ₂ system were adversely affected by several factors, including the overall home oxygen market climate and home care providers’ reluctance to invest in the higher cost of the TOTAL O ₂ system to achieve the lower monthly operating costs it affords. Recent changes in home oxygen reimbursement appear to be causing home care providers to examine their operating costs more carefully, which could have a positive impact on sales of the TOTAL O ₂ system. No assurances can currently be given regarding the level of success the Company could achieve with the TOTAL O ₂ system. Sales of the TOTAL O ₂ system and other transfilling products accounted for approximately 9%, 11%, and 10% of the Company’s sales in 2007, 2006, and 2005, respectively.

 

The technology for each of the devices described above has been licensed from the inventors thereof, with the exception of the CYPRESS OXYPneumatic and LOTUS conservers, which belongs to the Company. The Company has acquired exclusive licenses to manufacture and market the OXYMIZER devices, the OXYMATIC conservers, the SAGE device, the OXYCOIL tubing, and the TOTAL O ₂ system. See “Licensing and Related Agreements.”

 

Other Products .   The Company also offers a variety of ancillary products that support the principal oxygen conserving products. These include oxygen cylinders of various sizes and compositions, regulators, cannulas and connecting tubing, and assorted carrying bags. In addition, with a field sales force of manufacturer’s representatives and direct sales representatives covering the entire United States (see “Marketing”), the Company will utilize this team as part of a strategy to market and sell additional products that are targeted for the Company’s current customer base, the home care provider.

 

Products Under Development

 

During the fiscal years ended March 31, 2004 and 2003, the Company entered into contracts with outside vendors to develop products in the home oxygen market and sleep disorder market. Development efforts continue on these products, some of which have begun pre-clinical testing. No assurance can be given that any products developed pursuant to these contracts will be successfully marketed or that the Company will ever derive significant revenues or earnings from the sale of such products.

 

Research and Development

 

For the year ended March 31, 2007, 2006 and 2005, the Company expended approximately $1,466,000, $1,574,000, and $1,473,000 respectively, on research and development and has expended approximately $12,132,000 since its inception in August of 1982. The Company operates in an industry that is subject to rapid technological change, and its ability to compete successfully depends upon, among other things, its ability to stay abreast or ahead of new technological developments. Accordingly, the Company expects to expend significant amounts for the development or acquisition of new products or the improvement of existing products. The Company conducts research and development internally and also utilizes the services of outside firms and consultants for its research and development activities.

Licensing and Related Agreements

 

The Company has entered into license agreements (the “Inventor’s License Agreements”) with Brian L. Tiep, M.D., Robert E. Phillips, and Ben A. Otsap, the inventors of the OXYMIZER device (the “Inventors”), with respect to that device and each of the additional oxygen conserving devices developed by them.

 

Pursuant to the Inventor’s License Agreements, the Inventors granted to the Company an exclusive license (with the right to grant sublicenses) to manufacture, use, and sell such devices. Through September 2003, the Inventor’s License Agreements provided that the Company pay royalties to the Inventors on the net proceeds of sales of the device covered by the agreement at the rate of six percent (6%) on amounts up to ten (10) million dollars and three percent (3%) on amounts of ten (10) million dollars or more. As of September 2003, no further royalty payments are due. The Company is obligated to prosecute and defend, at its own expense, any infringement suits related to manufacture or sale of each device covered by any such agreement. Each Inventor’s License Agreement continues until the expiration of the last to expire of any patent covering the related device or, if no patent is issued, for 17 years.

 

The Company has also entered into a license agreement (the “Carleton License Agreement”) with the Life Support Division of Carleton (formerly Litton Life Support) for the TOTAL O ₂ Delivery System. Pursuant to the Carleton License Agreement, the Licensors granted to the Company an exclusive license (with the right to grant sublicenses) to manufacture, use, and sell such device in the health care market. The Carleton License Agreement provides that the Company pay royalties to the Licensor on the net proceeds of sales of the device covered by the agreement at the rate of seven percent (7%) and currently requires minimum annual royalties of $500,000. The Carleton License Agreement continues until the expiration of the last to expire of any patent covering the related device or until the Company ceases use of the licensed technology. The Licensors may terminate the Carleton License Agreement at an earlier date if the Company is in arrears for 30 days on any royalty payment or if the Company defaults in performing any other material obligation of the agreement and fails to cure such default within 30 days.

 

The Company has also entered into a license agreement (the “Phillips and Otsap License Agreement”) with Robert E. Phillips and Ben A. Otsap for the SAGE Oxygen Therapeutic Device. Pursuant to the Phillips and Otsap License Agreement, the Licensor grants to the Company an exclusive license (with the right to grant sublicenses) to manufacture, use, and sell such devices in the health care market. The Phillips and Otsap License Agreement provides that the Company pay royalties to the Licensor on the net proceeds of sales of the device covered by the agreement at the rate of three percent (3%) for unit sales up to 1,499 units, four percent (4%) for unit sales from 1,500 to 1,999 units per month, five percent (5%) for unit sales from 2,000 to 2,499 units per month and six percent (6%) for unit sales of 2,500 or more per month. The agreement also requires minimum annual royalties of $15,000 in the first year after FDA clearance is received to market the product and $30,000 per annum thereafter. The Phillips and Otsap License Agreement continues until the expiration of the last to expire of any patent covering the related devise or until the Company ceases use of the licensed technology. The Licensors may terminate the Phillips and Otsap License Agreement at an earlier date if the Company is in arrears for six (6) days on any royalty payment or if the Company defaults in performing any other material obligation of the agreement and fails to cure such default within 30 days.

 

Manufacturing and Sources of Supply

 

The Company tests and packages its products in its own facility and performs some manufacturing operations on certain products. Some manufacturing processes are conducted by other firms and the Company expects to continue using outside firms for certain manufacturing processes for the foreseeable future. All outside manufacturing is conducted under the supervision and control of the Company and with tooling provided by the Company.

 

Pursuant to a written agreement, the Company purchases finished units of the OXYMIZER devices from a supplier in Hong Kong. The Company believes that other injection molding facilities would be available in the event of a termination of this arrangement.

Production of the OXYMATIC 300 series, 2400, and 400 series conservers, the LOTUS, the CYPRESS and BONSAI pneumatic conservers, and the SAGE Oxygen Therapeutic Device are being handled internally with only a portion of the electronic assembly for electronic conservers being subcontracted outside the Company. The Company is currently subcontracting with two (2) electronic assembly facilities and believes that other facilities would be available in the event of an interruption of supply from the existing facilities.

 

Production of the TOTAL O ₂ system is being handled internally with a number of subassemblies being subcontracted outside the Company. The Company believes that there are alternate sources of supply for these subassemblies, including internal manufacturing as production quantities increase.

 

The Company is not aware of any shortages of materials necessary for the manufacture of its products. The Company provides customers the right to return merchandise for credit and requires payment within a time frame consistent with industry standards. The Company provides warranties for certain of its products based on industry standards and accrues for the estimated expenses associated with those warranties based on the best information available, primarily historical claims experience.

 

The Company has received ISO 13485 certification for its manufacturing facility based on criterion developed by the International Organization for Standardization, a quality standards organization with headquarters in Geneva, Switzerland. The Company has also received authorization for the same facility under the European Union’s Medical Devices directive, to affix the “CE Mark” to the Company’s products marketed throughout the world. The primary component of the certification process was an audit of the facility’s quality systems conducted by an independent agency authorized to perform conformity assessments under ISO guidelines and the Medical Devices Directive.

 

Marketing

 

The Company’s products are designed to reduce the cost of health care while maintaining or enhancing the therapeutic benefits to the patient and improving the user’s quality of life. The Company’s marketing efforts have focused primarily on providing home oxygen suppliers with products that they can utilize to increase their revenues and provide a better quality of care at less cost.

 

Home care providers have reportedly increased their revenues by assembling small portable systems incorporating the Company’s OXYMATIC electronic conserver or CYPRESS pneumatic conserver as a vehicle to attract new and additional patients to their business. The Company believes these lightweight, long-lasting, portable systems have both high professional and patient acceptance that allows the supplier promoting these products to attract new and additional customers.

 

A large portion of home oxygen patients is covered by Medicare or other government programs. Since June 1989 home oxygen suppliers have been reimbursed on a fixed, monthly-fee basis by Medicare. The monthly reimbursement amount does not vary with either the type of oxygen delivery equipment provided or the amount of oxygen supplied. Since monthly, per-patient revenues are fixed, home oxygen suppliers can only increase their per-patient profitability by reducing costs. The Company’s oxygen conserving products and TOTAL O ₂ Delivery System allow these suppliers to decrease their costs while providing their patients with improved therapeutic benefits and quality of life.

 

While the home respiratory care provider remains the primary focus of the Company’s marketing efforts, this focus has been augmented by a major effort to increase professional awareness. Promotional programs target respiratory care physicians, nurses, and therapists.

 

The Company markets its products directly to home oxygen suppliers throughout the U.S. The Company currently has a Senior Vice President of Sales & Marketing, two (2) Regional Vice Presidents of Sales, a manager of customer relations, an art and media manager, and two (2) in-house sales and customer service representatives who are in regular and frequent proactive telephone sales contact with customers and potential customers. In addition, the Company has a field sales force of seven (7) direct sales representatives and 16 independent manufacturer’s sales representatives to handle direct selling to customers throughout the United States and Canada. The Company also utilizes direct mail, trade show attendance, trade advertising, and a web site to promote the benefits of its

products to home care providers. Additionally, the Company actively seeks to increase professional awareness of its products through professional advertising and participation in professional meetings.

 

Home oxygen therapy markets outside the United States are, in most cases, at a much earlier stage of development. In many countries, these patients are cared for in institutional settings. As the trend develops to move patients into home care, opportunities for the Company’s products may increase. Sales of conservers in Europe, Canada, and Japan have become an important part of the Company’s business.

 

The Company has entered into exclusive distributorship agreements in Germany, Japan, and several other countries. The Company also has non-exclusive distributors in many other countries. Sales outside of the United States subject the Company to certain risks, including those involving political and economic factors, interruption of shipments of products, currency fluctuations and devaluations, and governmental restrictions and regulations.

 

Customers, Backlog and Orders

 

The Company presently has an active list of over 4,000 providers and hospital customers. Based upon information developed from various lists the Company believes that there are approximately 7,000 to 8,000 home oxygen providers and 3,000 general hospitals in the United States that are potential customers or customer sources for the Company. Of these 7,000 to 8,000 home care providers, approximately 48% are represented by three major national chain accounts. One national chain customer accounted for 41%, 36%, and 36% of net sales during 2007, 2006, and 2005, respectively, and one (1) other chain accounted for 11% of sales in 2005. One non-chain customer accounted for 11% of sales in 2006.

 

Several of these competitors are now marketing conservers in direct competition with the Company’s OXYMATIC electronic and CYPRESS pneumatic conservers. Some of these conservers provide only two-to-one (2:1) to three-to-one (3:1) savings ratios compared to continuous flow. As a result, these units, while weighing about the same as the OXYMATIC conserver, provide only one-third or one-half as much ambulation time. In addition, the Company is aware of two companies marketing oxygen conserving devices that claim similar oxygen savings ratios as the OXYMATIC conserver. The Company believes that some of these competitors have been able to offer their oxygen conservers as part of a bundle of products with perceived pricing advantages over the Company’s products. The Company does not know the level of sales achieved by these companies.

 

There are several other types of portable oxygen systems which compete with the Company’s OXYMATIC conservers but do not utilize oxygen conserving devices. Aluminum and steel oxygen cylinders with continuous flow regulators are utilized by some oxygen suppliers as portable systems. Although they do provide users with some portability, their size and bulk limit their use by patients who need or want to be truly ambulatory. The most commonly used of these cylinders is approximately three feet high, weighs over 20 pounds, and provides an average patient with less than five hours of oxygen. These systems are enjoying some level of success due to their lower unit-price advantage. The OXYMATIC electronic and CYPRESS pneumatic conservers allow the use of smaller, lighter cylinders and thus provide greater mobility.

 

Until the availability of portable systems utilizing the OXYMATIC conservers and the previously cited changes in Medicare oxygen reimbursement, liquid oxygen was the modality of choice for truly mobile users. Portable liquid oxygen systems that weigh 3.4 to 10 pounds, provide an average patient with six to eight hours of oxygen, compared to the smallest portable system which weighs 4.5 pounds and provides an average patient with 7.3 hours of oxygen. These systems are more costly than systems utilizing the OXYMATIC conservers and require frequent and expensive (often weekly) deliveries of bulk liquid oxygen to the patient’s home. In addition, the patient must remain within range of the base unit for refilling, unlike with the systems utilizing the OXYMATIC conservers with which a patient can take as many cylinders as needed to provide the amount of time necessary to be away from the base unit.

 

The Company is aware of one (1) combination oxygen concentrator and transfilling station being marketed in competition with the TOTAL O ₂ system. This system is larger and heavier and does not contain some of the integrated features found in the TOTAL O ₂ system. In addition, another competitor has recently introduced a transfilling station that also competes with the TOTAL O ₂ system. These competitors have substantially greater financial and marketing resources than the Company and have used these resources to aggressively market their products. The Company does not know the level of sales achieved for these systems by the competition.

 

Patents and Trademarks

 

The Company regards the products that it develops or licenses and its manufacturing processes as proprietary and relies on a combination of patents, trademarks, trade secret laws, and confidentiality agreements to protect its rights in its products. U.S. patents have been issued covering the original OXYMATIC conserver, the Lotus conserver, the CYPRESS OXYPneumatic conserver, the TOTAL O ₂ Delivery System, and the SAGE Oxygen Therapeutic Device. A number of foreign patent applications pertaining to the Company’s activities have also been issued.

 

The Company pursues a policy of obtaining patents for appropriate inventions related to products marketed or manufactured by the Company. The Company considers the patentability of products developed for it 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 could have an adverse impact upon the Company’s business.

 

There can be no assurance that patents, domestic or foreign, will be obtained with respect to the Company’s products, or that, if issued, they will provide substantial protection or be of commercial benefit to the Company. In addition, the patent laws of foreign countries may differ from those of the United States as to the patentability of the Company’s products and processes and, accordingly, the degree of protection afforded by foreign patents may be more or less than in the United States.

In the United States, although a patent has a statutory presumption of validity, the issuance of a patent is not conclusive as to such validity or as to the enforceable scope of its claims therein. The validity and enforceability of a patent can be attacked by litigation after its issuance by the U.S. Patent and Trademark Office. If the outcome of such litigation is adverse to the owner of the patent in that the patent is held to be invalid, other parties may then use the invention covered by the patent. Accordingly, there can be no assurance that patents with respect to the Company’s products, if issued, will afford protection against competitors with similar products, nor can there be any assurance that the patents will not be infringed upon or designed around by others.

 

Through patent searches, contacts in the industry, and representations and indemnities received from licensors and development partners, the Company seeks to ensure that its products do not infringe on the intellectual property rights claimed by others. However, interpretation of the scope and validity of existing patent rights may differ, and no assurance can be given that the Company products will in all cases not infringe on the rights of others. Moreover, any dispute regarding potential infringement may require substantial management and financial resources to defend.

 

The Company has obtained U.S. registration for the trademarks “OXYMIZER,” “OXYMATIC,” “LOTUS,” “OXYPneumatic,” “CHAD,” “OXYCOIL,” and “TOTAL O ₂ .” A series of foreign applications to register the trademark “OXYMIZER” in a number of countries of commercial interest to the Company have been filed.

 

Governmental Regulation

 

The commercialization of the conservers and transfill devices is subject to the Federal Food, Drug and Cosmetic Act (the “Food and Drug Act”) and to regulations issued thereunder. The Company anticipates that commercialization of other devices that it intends to market will also be subject to the Food and Drug Act. The Food and Drug Act is administered by the FDA, which has authority to regulate the marketing, manufacturing, labeling, packaging, and distribution of products subject to the Food and Drug Act. In addition, there are requirements under other federal laws and under state, local, and foreign statutes that may apply to the manufacture and marketing of the Company’s products. The Medical Device Amendments of 1976 to the Food and Drug Act (the “Amendments”) and the Safe Medical Device Act of 1990 significantly extended the authority of the FDA to regulate the commercialization of medical devices. The Amendments established three classifications of medical devices: Class I, Class II, and Class III. With respect to all three classes, the general provisions of the Food and Drug Act prohibit adulteration and misbranding. A medical device may be adulterated if the device is or could be adversely affected by its methods of manufacture, storage, or packaging. A medical device may be misbranded if its labeling is false or misleading or if its labeling does not contain specific information required by law applicable to such type of device. In addition, failure to register a medical device covered under the Food and Drug Act will render it misbranded under the Food and Drug Act.

 

All manufacturers of medical devices must register with the FDA and list all medical devices produced by them. This listing must be updated annually. In addition, prior to commercial distribution of additional devices, the manufacturer must file with the FDA and receive approval prior to the commencement of such commercial distribution, a notice setting forth certain information about the device, including the classification into which the manufacturer believes it falls.

 

Class I devices are subject only to the general controls concerning adulteration, misbranding, good manufacturing practices, record keeping, and reporting requirements. Class II devices must, in addition, comply with performance standards as promulgated by the FDA.

 

The Company has registered with the Bureau of Medical Devices of the FDA as a Medical Device Establishment and with the Department of Health Services of the State of California as a Medical Device Manufacturer. In addition, the Company has developed procedures to comply with FDA standards concerning good manufacturing practices, record keeping, and reporting and is ISO 13485 certified.

 

The Company has been granted permission by the FDA to market the OXYMIZER and the OXYMIZER Pendant as Class I devices. Permission has been granted to market the OXYMATIC, the CYPRESS OXYPneumatic, the BONSAI pneumatic, the LOTUS Electronic Oxygen conserver, the OXYCOIL, the TOTAL O ₂ Delivery System, and the SAGE Oxygen Therapeutic Device as Class II devices.

Employees

 

As of November 30, 2007, CHAD had 96 full-time employees and 2 part-time employees with 63 of the Company’s employees engaged in manufacturing and the remaining engaged in marketing, sales, administration, and management. None of the Company’s employees is represented by unions, and the Company believes its employee relations are satisfactory.

 

Properties

 

The Company’s offices and manufacturing facilities are situated in premises located in Chatsworth, California, and consist of approximately 55,500 square feet, at a monthly rental fee of $36,000 pursuant to a lease expiring on June 30, 2008. The Company intends to move to smaller facilities suitable for its scaled down operations if the Asset Sale is approved. The Company does not own any real property and does not anticipate acquiring any in the foreseeable future.

 

 

On November 16, 2007, the last trading day before the announcement of the execution of the Asset Purchase Agreement, the closing price for our common stock was $0.50 per share. On December 20, 2007, the last trading day before this proxy statement was printed, the closing price for our common stock on the American Stock Exchange was $0.26 per share. You are encouraged to obtain current market quotations for CHAD’s common stock in connection with voting your shares.

 

No dividends have ever been paid on our common stock, and we are currently restricted by the terms of the Asset Purchase Agreement and our secured credit facility from paying cash dividends.

 

As of December 24, 2007, the record date for the special meeting, there were approximately 217 registered holders of record of our common stock.

 

 

No cash dividends have been declared or paid during the periods presented.

 

Summary Unaudited Pro Forma Financial Data

 

The following summary unaudited pro forma financial data is based on the historical financial statements of CHAD. The pro forma statement of operations has been prepared assuming the Asset Sale and the sale of the transfilling assets was completed as of March 31, 2006. The pro forma financial data and notes thereto should be read in conjunction with the historical financial statements of CHAD included herein. The unaudited pro forma financial data is based on certain assumptions and estimates of management which are subject to change. The pro forma financial data is presented for illustrative purposes only and is not necessarily indicative of any future results of operations or the results that might have occurred if the Asset Sale had actually occurred on the indicated dates.

 

 

 

The unaudited pro forma financial information as of and for the six month period ended September 30, 2007, and for the year ended March 31, 2007, gives effect to the following pro forma adjustments:

 

Statement of Operations Data:

 

1 To give retroactive effect to the decrease in net sales, cost of sales and operating expenses estimated to be attributable to substantially all of the operating activities of the Company, other than that which is required to support the on going development of the sleep product line.

 

2 To reflect a reduction in interest expense related to the Company’s revolving credit line and long term debt, assuming the proceeds from the Asset Sale had been utilized to repay the outstanding indebtedness on these loans.

 

Balance Sheet Data:

 

3 Represents assets to be sold to and liabilities assumed by Inovo relative to the conserving product line.

 

4 Represents assets and liabilities of the transfilling product line that the Company intends to sell. No proceeds from the proposed sale of the transfilling assets have been included in the pro forma financial data.

 

5 Represents the gross cash sales price of $5,250,000 less estimated fees to be incurred upon the closing and operating losses to the closing date.

 

6 Reflects the repayment of amounts outstanding on the Company’s revolving line of credit and long term debt, as well as a prepayment penalty on the long term debt and the write-off of the unamortized debt financing fees associated with such debt.

 

(Note that the revolving line of credit repayment includes estimated additional borrowings through the estimated closing date of the Asset Sale to fund operating losses).

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION

 

Overview

 

The Company develops, assembles and markets medical devices that furnish supplementary oxygen to home health care patients. The Company was a pioneer in developing oxygen conserving devices that enhance the quality of life for patients by increasing their mobility and, at the same time, lowering 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 providers, and revisions (and proposed revisions) in governmental reimbursement policies. All of these factors, as described more fully below, have contributed to a more difficult market for the Company’s products.

 

The 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. Beginning January 1, 2006, the reimbursement procedures have been modified to provide that title for the equipment being used by a patient transfers to the patient after 36 months. 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 home care providers, thereby providing improved mobility for the patient and cost savings for home care providers. However, the uncertainties created by the new reimbursement procedures have adversely affected the market for our products by causing many home health care providers to delay product purchases as they seek to assess the impact of the new procedures and revisions.

 

On January 1, 2007, new rates that include a new reimbursement category for transfilling systems, like the Company’s TOTAL O ₂ ^® Delivery System, became effective. These new rates may have a positive impact on the market for these types of devices. However, in 2003 Congress enacted the Medicare Improvement and Modernization Act, which mandates that the monthly fees that homecare providers receive for servicing oxygen patients will be subject to competitive bidding. The current schedule is that this process will first be implemented in ten major markets on April 1, 2008. Continuing concern among home care providers about the potential impact of these changes in reimbursement may affect demand for the Company’s products.

 

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 care providers. Major national and regional home medical equipment chains have continued to expand their distribution networks through the acquisition of independent home care providers in strategic areas. Margins on sales to national chains are generally lower due to quantity pricing, and the Company is experiencing continued downward pressure on its average selling price. Four major national chains accounted for approximately 49%, 43%, and 53% of the Company’s net sales, for the years ended March 31, 2007, 2006, and 2005, respectively. One chain accounted for 41%, 36%,and 36% of sales in the years ended March 31, 2007, 2006, and 2005, respectively, and one other chain accounted for 11% of sales in the year ended March 31, 2005. The Company also had one significant non-chain customer that accounted for 11.0% of sales in the year ended March 31, 2006.

 

Continuing price pressure on our oxygen conservers and concerns about reimbursement changes have depressed operating results for the last two fiscal years. In addition, the Company’s increased dependence on a limited number of large customers has increased the volatility of our operating results. The Company believes that price competition and continuing industry consolidation will continue to affect the marketplace for oxygen therapy for the foreseeable future.

 

The Company has invested in the development of diagnostic and therapeutic devices for the high-growth sleep disorder market. In the next thirty days, we currently expect to file with the FDA an application for approval to market the first of these products. The Company cannot predict at this time when it will commercially introduce such products, nor can it estimate the level of success it might achieve in selling products for the sleep market.

Results of Operations for the Three and Six Month Periods Ended September 30, 2007

 

The Company’s operating results deteriorated significantly during the three-month period ended September 30, 2007. Net sales for the three and six-month periods ended September 30, 2007 decreased by $1,777,000 (35.7%) and $3,279,000 (31.4%), respectively, as compared to the same periods in the prior year. The primary reasons for the decrease in sales for the three and six-month periods ended September 30, 2007, were (i) a decline of 23.4% and 13.6%, respectively, in unit sales of conservers, (ii) price reductions on domestic conservers, (iii) decreases in TOTAL O ₂ sales and (iv) a decline in sales to foreign distributors. Unit sales of conservers and therapeutic devices for the three and six-month periods ended September 30, 2007, decreased 35.6% and 28.0% as compared to the same periods in the prior year. Revenues from conserver and therapeutic device sales decreased by 44.6% and 35.7%, respectively for the three and six-month periods ended September 30, 2007 as compared to prior year. The Company believes that the reduction in unit sales is largely the result of continuing uncertainty regarding government reimbursement polices, which has caused many dealers to defer or reduce their purchases of new equipment. In addition, conserver sales to the Company’s largest customer declined by approximately 43.9% and 24.5%, respectively, for the three and six months ended September 30, 2007, as compared to the prior year’s period as the Company has encountered increased competition in the sale of pneumatic conservers to such customer. As noted above, management expects continued downward pressure on its average selling price. In addition, future operating results may be increasingly dependent upon purchasing decisions of a limited number of large customers.

 

Revenues from TOTAL O ₂ sales decreased 51.4% and 50.4% for the three and six-month periods ended September 30, 2007, as compared to the same period in the prior year. Ongoing concerns regarding potential additional changes to reimbursement procedures continue to negatively impact sales of the TOTAL O ₂ System.

 

Sales to foreign distributors represented 19.6% and 24.0% and 14.2% and 22.1% of net sales for the three and six-month periods ended September 30, 2007 and 2006, respectively. Foreign sales declined by 47.8% and 55.9% for the three and six-month periods as compared to the same periods in the previous year. This decrease was driven by a 76.4% and an 80.8% decrease in conserver sales for the three and six-month periods ended September 30, 2007, as compared to the same period in the prior year. Notwithstanding these declines, management believes there may be substantial growth opportunities for the Company’s products in a number of foreign markets, and currently 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 are denominated in US dollars.

 

Cost of sales as a percent of net sales increased from 67.5% to 81.3% for the three-month period ended September 30, 2007, and from 67.2% and 80.6% for the six-month period ended September 30, 2007, as compared to the same periods in the prior year. The increase in cost of sales as a percentage of net sales was primarily due to the decrease in sales as compared to consistent fixed manufacturing costs, as well as continued downward price pressures in the marketplace and an increase in sales to high volume purchasers that receive discounted rates. We currently expect downward price pressure for the foreseeable future. While the Company has sought to reduce manufacturing costs by transferring some operations to overseas contractors, such efforts have not yet produced significant cost savings, largely as a result of quality and reliability issues encountered in qualifying such overseas contractors.

 

Selling, general, and administrative expenditures increased from 33.8% to 43.9% and from 32.4% and 41.2%, respectively as a percentage of net sales for the three and six-month periods ended September 30, 2007, as compared to the same periods in the prior year. While the Company’s ongoing cost reduction efforts have decreased actual selling, general, and administration expenditures, decreases in sales revenues have resulted in selling, general, and administrative costs increasing as a percentage of net sales. Research and development expenses increased by $70,000 and $196,000, respectively for the three and six-month periods ended September 30, 2007, as compared to the same periods in the prior year. Currently management expects research and development expenditures to total approximately $1,754,000 in the fiscal year ending March 31, 2008, on projects to enhance and expand the Company’s sleep product line. During fiscal year 2007, the Company spent $1,466,000 on research and development. The Company wrote down a $48,000 license fee during the three months ended September 30, 2007 when the Company determined to stop development of the product lines related to that license fee.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. 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 2010 through 2013. At September 30, 2007, the Company has fully reserved against all of its Federal and State net operating loss carryforwards. 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.

 

Results of Operations for the Years Ended March 31, 2007 and 2006

 

Net sales for the years ended March 31, 2007 and 2006 decreased by $3,373,000 (15.1%) and $1,933,000 (8.0%), respectively, as compared to the same periods in the prior years. The primary reasons for the decrease in sales for the years ended March 31, 2007 and 2006, respectively as compared to the previous years have been a reduction in sales volume, and the price reductions on conservers, as well as decreases in TOTAL O ₂ system sales and a decrease in sales to foreign distributors. Worldwide unit sales of conservers and therapeutic devices for the years ended March 31, 2007 and 2006 decreased 10.0% and increased .8% respectively, while the decrease in worldwide revenues from conserver and therapeutic device sales was 16.9% and 11.3% for the same periods. Domestic conserver and therapeutic device unit sales decreased 2.6% and 13.6%, while international conserver and therapeutic device unit sales decreased 40.1% and increased 203.7% for the years ended March 31, 2007 and 2006 respectively. Decreased per-unit conserver revenues over the past two years are due to price reductions, the impact of national chain contract pricing, and the changing product mix, as pneumatic conservers are generally priced lower than electronic conservers. As noted above, the Company is experiencing continued downward pressure on its average selling price. In addition, future operating results may be increasingly dependent upon purchase decisions of a limited number of large customers.

 

Revenues from TOTAL O ₂ system sales decreased 25.5% for the year ended March 31, 2007, and increased 2.8% for the year ended March 31, 2006 as compared to the same periods in the prior years. The Company believes that the January 2, 2006, modification of reimbursement procedures that provides for the title of equipment being used by a patient to transfer to the patient after 36 months, and concern over the implementation of competitive bidding and its potential impact on reimbursements negatively impacted sales of TOTAL O ₂ during the year ended March 31, 2007. The new reimbursement category created by CMS for transfilling systems that went into effect on January 1, 2007, may have a positive impact on the market for transfilling systems, such as the TOTAL O ₂ system, once the impact of the implementation of competitive bidding becomes settled.

 

Sales to foreign distributors represented 16.8% and 19.5% of net sales the years ended March 31, 2007 and 2006, respectively. Foreign sales declined by 26.9% for the year ended March 31, 2007 after showing a 208.4% increase for the year ended March 31, 2006 as compared to the respective prior year periods. The decrease for the year ended March 31, 2007 was driven by a 40.6% decrease in conserver sales compared to the prior year. The year ended March 31, 2006 saw a 331.2% increase in conserver sales to foreign distributors over the previous year. Management believes the spike in conserver sales to foreign distributors in the 2006 fiscal year resulted in large part from certain foreign customers ramping up their inventory of conservers in order to comply with regulatory requirements.

 

Cost of sales as a percent of net sales increased from 67.6% to 72.12% and from 60.0% to 67.6% for the years ended March 31, 2007 and 2006, respectively. This was partially a result of the downward price pressures in the market place, as well as increased sales to chain customers and those with quantity pricing arrangements. We currently expect continued downward price pressure for the foreseeable future. In accordance with the Company’s policy to provide a reserve against excess or slow-moving inventory, in March 2006 the Company established a $739,000 reserve against certain slow-moving inventories related to its SAGE Oxygen Therapeutic Device. In the latter part of fiscal 2005, the Company had a significant inventory build up to fill certain customer orders and anticipated customer orders. Certain of these orders did not materialize. Prior to the application of the reserve, the book value of the SAGE inventory was approximately $1,484,000. In March of 2007 the Company increased its reserve for slow-moving inventory by $185,000 as a result of the impact of current market conditions on sales of the SAGE device as well as the impact of the introduction of the new OMNI-5 and OMNI-2 oxygen transfilling systems. Sales of the SAGE inventory continue, and the Company intends to continue to market and support the SAGE Oxygen Therapeutic Device in the future.

Selling, general, and administrative expenditures increased from 30.4% to 33.3% and from 28.6% to 30.4% of net sales for the year ended March 31, 2007 and 2006, respectively, as compared to the same period in the prior year primarily due to the decrease in sales. While the Company’s ongoing cost reduction efforts have helped align staffing and operating expenses more closely with current sales expectations, and have decreased actual selling, general, and administrative expenditures, decreases in sales revenues have resulted in selling, general and administrative costs increasing as a percentage of net sales. Research and development expenses decreased by $108,000 and increased $101,000 for the years ended March 31, 2007 and 2006, respectively, as compared to the prior years.

 

Based on current earnings performance and projections, a full valuation allowance $2,046,000 has been placed on the Company’s deferred tax assets. 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.

 

Financial Condition

 

The significant deterioration in the Company’s operating results during the three months ended September 30, 2007 has contributed to a worsening of the Company’s financial condition. During that period, the Company’s negative cash flow from operations was approximately $1,647,000 as compared to the negative cash flow from operations of approximately $69,000 in the three months ended June 30, 2007. The cash raised by the Company through its borrowings from Calliope Capital Corporation (discussed below) have largely been exhausted to fund on-going operations in light of the decline in operating results. The Company does not have in place additional capital resources to continue to fund operating losses at the level experienced during the three months ended September 30, 2007.

 

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 substantially all of the assets of the Company related to the oxygen conserver business (the “Asset Sale”). Pursuant to the Asset Purchase Agreement, Inovo would assume certain liabilities and obligations related to the Company’s oxygen conserver business. If the Asset Sale is approved, the Company will no longer develop and sell oxygen conserver products. The Company will retain the assets related to its transfilling business, as well as products in development for the sleep disorder market. The Company’s future efforts will focus on the sleep disorder market and the Company will seek to sell the transfilling assets.

 

The selling price for the Assets is $5,250,000, subject to adjustment for changes in working capital between the execution date of the Asset Purchase Agreement and closing date (the “Selling Price”). The Selling Price may not exceed $5,500,000. There is no limit on the potential downward adjustment of the Selling Price based upon a decline in the Company’s working capital. If the Asset Sale is approved, the Company will use the proceeds to pay down its secured credit line and other obligations. After paying such obligations and transaction fees, the Company expects it will receive net proceeds of approximately $1.1 million from the Asset Sale.

 

The Asset Sale is subject to certain closing conditions including approval by the Company’s shareholders. If the Asset Sale is approved and 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 approved by the shareholders or 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.

 

In order to fund its operations pending the shareholder vote on the Asset Sale, the Company may be dependent upon its secured credit line. As of November 16, 2007, the Company had drawn approximately $1,557,000 on this $2,750,000 facility. However, based upon the lender’s calculation of the Company’s borrowing base, the Company had largely exhausted its available drawings on the secured credit line as of that date. Future draws on the secured credit line will depend upon a number of factors, including the value of eligible assets owned by the Company and the lender’s calculation of the Company’s borrowing base. If the Company is unable to continue to draw funds under the secured credit line, then it may lack sufficient cash resources to continue its business operations. Limitations

imposed by the lender on the availability of funds under the secured credit line could also constrain the Company’s ability to meet all of its obligations on a timely basis. In order to address this uncertainly and meet its immediate cash requirements the Company has entered into an agreements with two of our executive officers to borrow $300,000 with a potential of borrowing an additional $700,000. The Company does not currently have in place any other sources of short term funding. Consequently, inability to draw adequate funds under the secured credit line or to obtain such funds from other sources could force the Company to cease or curtail its business operations.

 

At September 30, 2007, the Company had cash totaling $387,000 or 3.7% of total assets, as compared to $375,000 (3.2% of total assets) at March 31, 2007. Net working capital decreased from $7,266,000 at March 31, 2007, to $4,976,000 at September 30, 2007. Net accounts receivable decreased $601,000 during the six months ended September 30, 2007, due to the decrease in sales and the timing of payments from significant customers. Future increases or decreases in accounts receivable will generally coincide with sales volume fluctuations and the timing of shipments to foreign customers. During the same period, inventories decreased $772,000. The Company attempts to maintain sufficient inventories to meet its customer needs as orders are received and new products are introduced. Thus, future inventory and related accounts payable levels will be impacted by the ability of the Company to maintain its safety stock levels. If safety stock levels drop to target amounts, then inventories in subsequent periods will increase more rapidly as inventory balances are replenished. The Company experienced a significant inventory build up in the latter part of fiscal 2005 to fill certain customer orders and anticipated customer orders of the SAGE device. Certain of these orders did not materialize or were deferred. As of September 30, 2007, the Company has a reserve of $797,000 against its SAGE inventory.

 

Liquidity and Capital Resources

 

Historically, the Company has depended primarily upon its cash flow from operations to finance its inventory and operating expenses and to meet its capital requirements. However, recent operating trends have required the Company to seek outside financing in order to enhance its cash resources. The Company’s cash flow for the six months ended September 30, 2007 was negative and the Company cannot predict when it will generate a positive cash flow from operations. The Company anticipates capital expenditures during the next twelve months to be approximately $100,000. Moreover, the Company’s efforts to enter the sleep disorder market may require significant cash resources for product development, manufacturing, and marketing. At the date of filing, the Company had substantially exhausted any available funds on its secured credit line and its term note. 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 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. Total borrowings against the line of credit were $1,094,000 at September 30, 2007 while total borrowings against the Convertible Note were $750,000.

 

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. 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.

 

In order to enhance our near-term liquidity, on December 19, 2007, our Board of Directors approved a credit facility with Mr. Earl Yager and Mr. Thomas Jones, our Chief Executive Officer and our Chairman of the Board, respectively (the “Credit Facility”). Pursuant to the terms of the Credit Facility, we may draw an aggregate of $1,000,000, subject to certain conditions. We made an initial draw down in the principal amount of $300,000.

Notes issued under the Credit Facility will 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 Asset Sale or (ii) August 30, 2010. The notes will be secured by the assets of the Company, but the security interest will be subordinated to the security interest of Calliope Capital Corporation discussed below. In connection with the Credit Facility, Mr. Yager and Mr. Jones each will receive warrants to purchase our common stock at a price per share equal to 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 (“Exercise Price”). 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 we may make under the Credit Facility.

 

The Board of Directors appointed two independent members of the Board to evaluate and negotiate the terms of the Credit Facility. Neither Mr. Yager nor Mr. Jones participated in the meeting of the Board of Directors which approved the Credit Facility. In its evaluation of the Credit Facility, the independent members of the Board of Directors considered the terms of other potential funding sources and determined that the Credit Facility was more favorable to the Company and its shareholders than the terms proposed by other sources of funding. The Board of Directors also consulted with financial and legal advisers and considered the Company’s current financial condition, its recent operating performance and market conditions for distressed borrowers in its evaluation of the Credit Facility.

 

The following table aggregates all of the Company’s material contractual obligations as of September 30, 2007:

 

 

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 have been provided for by cash flows generated from operations. Please see Note 8 to the financial statements in the 2007 Annual Report.

 

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 of 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.

 

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

 

Significant Accounting Policies

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and

the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates under different assumptions and conditions. Management believes that the following discussion addresses the accounting policies and estimates that are most important in the portrayal of the Company’s financial condition and results.

 

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

 

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

 

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

 

Deferred income taxes  — the Company provides a valuation allowance to reduce deferred tax assets to the 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.

 

Accounting Standards

 

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 implementation of this interpretation did not have a significant impact on the Company’s financial statements.

 

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 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.

 

 

If a shareholder wishes to present a proposal at our 2008 annual meeting and the proposal is not intended to be included in the Company’s Proxy Statement relating to the 2008 annual meeting, the shareholder must give advance notice to the Company prior to the deadline for the annual meeting. In order to be deemed properly presented, the notice of a proposal must be delivered to the Company’s Corporate Secretary no later than September 9, 2008, which is 45 calendar days prior to the anniversary of the 2007 annual meeting. However, in the event the 2008 annual meeting is called for a date which is not within 30 days of the anniversary date of the 2007 annual meeting, shareholder proposals intended for presentation at the 2007 annual meeting must be received by the Corporate Secretary no later than the close of business on the tenth (10th) day following the date on which public announcement of the date of the 2008 annual meeting is first made. If a shareholder gives notice of such proposal after September 9, 2008, the proxy solicited by the Board of Directors for the 2008 annual meeting will confer discretionary authority to vote on such proposal at that meeting, which may include a vote against such shareholder proposal.

 

WHERE YOU CAN FIND ADDITIONAL INFORMATION

 

CHAD files annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any reports, proxy statements or other information that we file with the SEC at the following location of the SEC:

 

Public Reference Room

100 F Street, N.E.

Washington, D.C. 20549

 

Please call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. You may also obtain copies of this information by mail from the Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C. 20549, at prescribed rates. CHAD’s public filings are also available to the public from document retrieval services and the Internet website maintained by the SEC at www.sec.gov.

 

Any person, including any beneficial owner, to whom this proxy statement is delivered, may request copies of reports, proxy statements or other information concerning us, without charge, by written or telephonic request directed to us at CHAD Therapeutics, Inc., 21622 Plummer Street, Chatsworth, California 91311, not later than January 15, 2008, Attention: Corporate Secretary. No persons have been authorized to give any information or to make any representations other than those contained in this proxy statement and, if given or made, such information or representations must not be relied upon as having been authorized by us or any other person. This proxy statement is dated December 28, 2007. You should not assume that the information contained in this proxy statement is accurate as of any date other than that date, and the mailing of this proxy statement to shareholders shall not create any implication to the contrary.

 

By Order of the Board of Directors,

 

Paula O’ Connor

Secretary

 

December 28, 2007

 

Index to Financial Statements

 

 

Audit Report

 

The Board of Directors
and Shareholders
CHAD Therapeutics, Inc.

 

We have audited the accompanying balance sheet of CHAD Therapeutics, Inc. as of March 31, 2007, and the related statement of operations, stockholders’ equity, and cash flows for the year ended March 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CHAD Therapeutics, Inc. as of March 31, 2007, and the results of its operations and its cash flows for the year ended March 31, 2007, in conformity with accounting principles generally accepted in the United States of America.

 

A Corporation of Certified Public Accountants

Encino, California

May 25, 2007

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors
and Shareholders
CHAD Therapeutics, Inc.

 

We have audited the accompanying balance sheet of CHAD Therapeutics, Inc. as of March 31, 2006, and the related statements of operations, shareholders’ equity, and cash flows for each of the years in the two-year period ended March 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CHAD Therapeutics, Inc. as of March 31, 2006, and the results of its operations and its cash flows for each of the years in the two-year period ended March 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

 

KPMG LLP

 

Los Angeles, California

May 5, 2006