#### **UNITED STATES**

#### **SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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#### **FORM 10-Q**

#### ** **

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarterly periodended January 31, 2005**

** **

**or**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commission File Number 0-26670**

 

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#### **NORTH AMERICANSCIENTIFIC, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                     | ** ** | **51-0366422**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | Identification  No.) |

 

**20200 Sunburst Street, Chatsworth, CA 91311**

(Address of principal executive offices)

 

**(818) 734-8600**

(Registrant’s telephone number, includingarea code)

 

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Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

 

ý Yes     o No

 

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct).

 

ý Yes     o No

 

The number of shares of Registrant’sCommon Stock, $.01 par value, outstanding as of April 12, 2005 was16,316,041 shares.

 

 

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**NORTH AMERICANSCIENTIFIC, INC.**

**Index**

** **
| ** **                                                                                      | ** **                                                                                      | **Page**   |
|-------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                      | ** **                                                                                      | ** ** |
| ** **                                                                                      | **Part I – Financial Information**                                                         | ** ** |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Item 1.**                                                                                     | **Financial Statements**                                                                        | ** ** |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Consolidated Balance Sheets  as of January 31, 2005 and October 31, 2004**                    | **3**                                                                                           |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Consolidated  Statements of Operations for the three months ended January 31, 2005 and 2004** | **4**                                                                                           |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Consolidated  Statements of Cash Flows for the three months ended January 31, 2005 and 2004** | **5**                                                                                           |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Condensed  Notes to the Consolidated Financial Statements**                                   | **6**                                                                                           |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Item  2.**                                                                                    | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | **16**     |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Item  3.**                                                                                    | **Quantitative  and Qualitative Disclosures about Market Risk**                                 | **22**     |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Item 4.**                                                                                     | **Controls and  Procedures**                                                                    | **23**     |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| ** **                                                                                      | **Part II – Other Information**                                                            | ** ** |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Item 6.**                                                                                     | **Exhibits**                                                                                    | **23**     |
| ** **                                                                                      | ** **                                                                                      | ** ** |
| **Signatures**                                                                                  | **24**                                                                                          |

 

2

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**PART I – FINANCIAL INFORMATION**

 

###### **Item 1.**        FinancialStatements

###### ** **

**NORTHAMERICAN SCIENTIFIC, INC.**

** **

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                      | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                                                                                                                                                                                      | ** ** | **2005**        | ** ** | **2004**        | ** ** |
| ** **                                                                                                                                                                                                      | ** ** | **(Unaudited)** | ** ** | ** **      | ** ** |
| **Assets**                                                                                                                                                                                                      |       |            |       |            |       |
|                                                                                                                                                                                                            |       |            |       |            |       |
| Current assets                                                                                                                                                                                                  |       |            |       |            |       |
| Cash and cash equivalents                                                                                                                                                                                       |       | $               | 1,691,000  |            | $          | 2,334,000 |   |
| Marketable securities                                                                                                                                                                                           |       | 10,255,000      |       | 10,046,000      |       |
| Accounts receivable                                                                                                                                                                                             |       | 5,829,000       |       | 7,132,000       |       |
| Inventories                                                                                                                                                                                                     |       | 4,409,000       |       | 4,871,000       |       |
| Prepaid expenses and other current assets                                                                                                                                                                       |       | 861,000         |       | 1,061,000       |       |
| ** **                                                                                                                                                                                                      | ** ** | ** **      |       |            |       |
| Total current assets                                                                                                                                                                                       |       | 23,045,000      |       | 25,444,000      |       |
| Non-current marketable securities                                                                                                                                                                          |       | —          |       | 2,600,000       |       |
| Equipment and leasehold improvements                                                                                                                                                                            |       | 3,740,000       |       | 4,127,000       |       |
| Goodwill                                                                                                                                                                                                        |       | 18,732,000      |       | 18,732,000      |       |
| Intangible assets                                                                                                                                                                                               |       | 28,929,000      |       | 29,504,000      |       |
| Other assets                                                                                                                                                                                                    |       | 132,000         |       | 132,000         |       |
| ** **                                                                                                                                                                                                      | ** ** | ** **      |       |            |       |
| Total assets                                                                                                                                                                                                    |       | $               | 74,578,000 |            | $          | 80,539,000 |   |
|                                                                                                                                                                                                            |       |            |       |            |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                  |       |            |       |            |       |
|                                                                                                                                                                                                            |       |            |       |            |       |
| Current liabilities                                                                                                                                                                                             |       |            |       |            |       |
| Accounts payable                                                                                                                                                                                                |       | $               | 1,523,000  |            | $          | 2,061,000 |   |
| Accrued expenses                                                                                                                                                                                                |       | 5,576,000       |       | 6,808,000       |       |
| Deferred revenue                                                                                                                                                                                                |       | 5,553,000       |       | 6,293,000       |       |
| ** **                                                                                                                                                                                                      | ** ** | ** **      |       |            |       |
| Total current liabilities                                                                                                                                                                                       |       | 12,652,000      |       | 15,162,000      |       |
| ** **                                                                                                                                                                                                      | ** ** | ** **      |       |            |       |
| Commitments and contingencies                                                                                                                                                                                   |       |            |       |            |       |
|                                                                                                                                                                                                            |       |            |       |            |       |
| Stockholders’ Equity                                                                                                                                                                                       |       |            |       |            |       |
| Preferred stock, $0.01 par value, 2,000,000  shares authorized; no shares issued                                                                                                                                |       | —          |       | —          |       |
| Common stock, $0.01 par value, 40,000,000  shares authorized, 16,419,230 and 16,308,487 shares issued; 16,311,204 and  16,200,461 shares outstanding as of January 31, 2005 and October 31, 2004,  respectively |       | 167,000         |       | 163,000         |       |
| Additional paid-in capital                                                                                                                                                                                      |       | 120,415,000     |       | 120,220,000     |       |
| Treasury stock, at cost – 108,026 common  shares                                                                                                                                                           |       | (129,000        | )          | (129,000        | )          |
| Accumulated deficit                                                                                                                                                                                             |       | (58,527,000     | )          | (54,877,000     | )          |
| ** **                                                                                                                                                                                                      | ** ** | ** **      |       |            |       |
| Total stockholders’ equity                                                                                                                                                                                 |       | 61,926,000      |       | 65,377,000      |       |
| ** **                                                                                                                                                                                                      | ** ** | ** **      |       |            |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                 |       | $               | 74,578,000 |            | $          | 80,539,000 |   |

 

See condensed notes to the consolidated financial statements.

 

3

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**NORTH AMERICANSCIENTIFIC, INC.**

** **

**Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                                     | ** ** | **Three Months Ended January 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                           |       |                               |       |   |   |
| Revenue                                        |       |                               |       |   |   |
| Product                                        |       | $                                  | 5,373,000  |   | $ | 3,363,000 |   |
| Service                                        |       | 2,791,000                          |       | — |   |
|                                           |       |                               |       |   |   |
| Total revenue                                  |       | 8,164,000                          |       | 3,363,000 |   |
|                                           |       |                               |       |   |   |
| Cost of revenue                                |       |                               |       |   |   |
| Product                                        |       | 4,225,000                          |       | 1,905,000 |   |
| Service                                        |       | 1,009,000                          |       | — |   |
|                                           |       |                               |       |   |   |
| Total cost of revenue                          |       | 5,234,000                          |       | 1,905,000 |   |
|                                           |       |                               |       |   |   |
| Gross profit                                   |       | 2,930,000                          |       | 1,458,000 |   |
|                                           |       |                               |       |   |   |
| Operating expenses                             |       |                               |       |   |   |
| Selling expenses                               |       | 2,139,000                          |       | 779,000 |   |
| General and administrative expenses            |       | 2,302,000                          |       | 3,114,000 |   |
| Research and development                       |       | 1,632,000                          |       | 166,000 |   |
| Amortization of intangible assets              |       | 575,000                            |       | 11,000 |   |
|                                           |       |                               |       |   |   |
| Total operating expenses                       |       | 6,648,000                          |       | 4,070,000 |   |
|                                           |       |                               |       |   |   |
| Loss from operations                           |       | (3,718,000                         | )          | (2,612,000 | ) |
| Interest and other income                      |       | 69,000                             |       | 211,000 |   |
|                                           |       |                               |       |   |   |
| Loss before provision for income taxes         |       | (3,649,000                         | )          | (2,401,000 | ) |
| Provision for income taxes                     |       | —                             |       | — |   |
|                                           |       |                               |       |   |   |
| Loss from continuing operations                |       | (3,649,000                         | )          | (2,401,000 | ) |
| Loss from discontinued operation               |       | —                             |       | (1,529,000 | ) |
|                                           |       |                               |       |   |   |
| Net loss                                       |       | $                                  | (3,649,000 | ) | $ | (3,930,000 | ) |
|                                           |       |                               |       |   |   |
| Basic and diluted loss per share:              |       |                               |       |   |   |
| Continuing operations                          |       | $                                  | (0.22      | ) | $ | (0.23 | ) |
| Discontinued operation                         |       | —                             |       | (0.15 | ) |
|                                           |       |                               |       |   |   |
| Net loss per share                             |       | $                                  | (0.22      | ) | $ | (0.38 | ) |
|                                           |       |                               |       |   |   |
| Weighted average number of shares  outstanding |       | 16,256,775                         |       | 10,283,237 |   |

 

See condensed notes to the consolidated financial statements.

** **

**4**

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** **

**NORTH AMERICANSCIENTIFIC, INC.**

** **

**Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended January 31,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                                                         |       |                               |       |   |   |
| Cash flows from operating activities:                                        |       |                               |       |   |   |
| Net loss                                                                     |       | $                                  | (3,649,000 | ) | $ | (3,930,000 | ) |
| Loss from discontinued operation                                             |       | —                             |       | 1,529,000 |   |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                               |       |   |   |
| Depreciation and amortization                                                |       | 868,000                            |       | 201,000 |   |
| Non-cash stock-based compensation                                            |       | —                             |       | 351,000 |   |
| Provision for doubtful accounts                                              |       | —                             |       | 20,000 |   |
| Changes in assets and liabilities, net of  discontinued operation:           |       |                               |       |   |   |
| Accounts receivable                                                          |       | 1,303,000                          |       | 74,000 |   |
| Inventories                                                                  |       | 462,000                            |       | (82,000 | ) |
| Prepaid and other current assets                                             |       | 13,000                             |       | (623,000 | ) |
| Accounts payable                                                             |       | (494,000                           | )          | (360,000 | ) |
| Accrued expenses                                                             |       | (465,000                           | )          | 327,000 |   |
| Income tax receivable                                                        |       | —                             |       | 496,000 |   |
| Deferred revenue                                                             |       | (740,000                           | )          | — |   |
|                                                                         |       |                               |       |   |   |
| Net cash used in continuing operations                                       |       | (2,702,000                         | )          | (1,997,000 | ) |
| Net cash used in discontinued operation                                      |       | (454,000                           | )          | (2,432,000 | ) |
|                                                                         |       |                               |       |   |   |
| Net cash used in operating activities                                        |       | (3,156,000                         | )          | (4,429,000 | ) |
|                                                                         |       |                               |       |   |   |
| Cash flows from investing activities:                                        |       |                               |       |   |   |
| Proceeds from maturity of marketable  securities                             |       | 2,391,000                          |       | 11,033,000 |   |
| Purchase of marketable securities                                            |       | —                             |       | (5,989,000 | ) |
| Capital expenditures                                                         |       | (77,000                            | )          | (158,000 | ) |
|                                                                         |       |                               |       |   |   |
| Net cash provided by investing activities                                    |       | 2,314,000                          |       | 4,886,000 |   |
|                                                                         |       |                               |       |   |   |
| Cash flow from financing activities:                                         |       |                               |       |   |   |
| Proceeds from exercise of stock options and  stock purchase plan             |       | 199,000                            |       | 456,000 |   |
|                                                                         |       |                               |       |   |   |
| Net cash provided by finance activities                                      |       | 199,000                            |       | 456,000 |   |
|                                                                         |       |                               |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                        |       | (643,000                           | )          | 913,000 |   |
|                                                                         |       |                               |       |   |   |
| Cash and cash equivalents at beginning of  period                            |       | 2,334,000                          |       | 1,761,000 |   |
|                                                                         |       |                               |       |   |   |
| Cash and cash equivalents at end of period                                   |       | $                                  | 1,691,000  |   | $ | 2,674,000 |   |

 

See condensed notes to the consolidated financial statements.

 

5

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**NORTH AMERICANSCIENTIFIC, INC.**

** **

**Condensed Notes to Consolidated FinancialStatements**

**(Unaudited)**

** **

**NOTE 1 – SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

*Basis ofPresentation*

* *

The accompanying consolidated financial statements ofNorth American Scientific, Inc. (the “Company”) are unaudited, other than theconsolidated balance sheet at October 31, 2004, and reflect all materialadjustments, consisting only of normal recurring adjustments, which managementconsiders necessary for a fair statement of the Company’s financial position,results of operations and cash flows for the interim periods.  The results of operations for the currentinterim periods are not necessarily indicative of the results to be expectedfor the entire fiscal year.

 

These consolidated financial statements have beenprepared in accordance with the rules and regulations of the Securities andExchange Commission (“SEC”).  Certaininformation and footnotes normally included in financial statements prepared inaccordance with generally accepted accounting principles in the United Statesof America have been condensed or omitted pursuant to these rules andregulations.  These consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements and the notes thereto included in the Company’s Form 10-K,as filed with the SEC for the year ended October 31, 2004.

 

Certain reclassifications have been made to priorperiod balances in order to conform to the current period presentation.

 

*Management’s Plans*

* *

The accompanying financial statements have beenprepared on a going concern basis, which contemplates the realization of assetsand liquidation of liabilities in the normal course of business. However, theCompany has continued to incur substantial net losses and to use substantialamounts of cash.  As of January 31, 2005,the Company has an accumulated deficit of $58.5 million, cash, cash equivalentsand marketable securities of $11.9 million and no debt.

 

Based on the Company’s current operating plans,management believes existing cash resources and cash forecasted by management tobe generated by operations will be sufficient to meet working capital andcapital requirements through at least the next twelve months. Also, management’splans to attain profitability and generate additional cash flows includeincreasing revenues from existing and new products and services, realizing thebenefits of the integration of historic operation and NOMOS operations and afocus on cost control. However, there is no assurance that management will besuccessful with these plans. If events and circumstances occur such that theCompany does not meet its current operating plan as expected, and the Companyis unable to raise additional financing, the Company may be required to furtherreduce certain discretionary spending, which could have a material adverseeffect on the Company’s ability to achieve its intended business objectives.

 

6

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*Use of Estimates*

* *

In the normal course of preparing the financialstatements in conformity with generally accepted accounting principles in theUnited States of America, management is required to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and reported amounts of revenue and expenses during the reportingperiod.  Actual results could differ fromthose amounts.

 

*Accounting forStock-based Compensation*

* *

The Company accounts for its stock option awards toemployees and directors using the intrinsic value method of accounting inaccordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations.  The Company has provided additionaldisclosures required by Statement of Financial Accounting Standards (“SFAS”)No. 123, “Accounting for Stock-Based Compensation.”

 

Had compensation cost for the Company’s stock optionsbeen recognized based upon the estimated fair value on the grant date under thefair value methodology prescribed by SFAS No. 123, as amended by SFAS No. 148,the Company’s net loss and loss per share would have been as follows:

 
| ** **                                     | ** ** | **Three months ended January 31,** | ** ** |
|------------------------------------------------|------------|------------------------------------|------------|
| ** **                                     | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                           |       |                               |       |   |   |
| Net loss, as reported                          |       | $                                  | (3,649,000 | ) | $ | (3,930,000 | ) |
| Add: stock-based compensation recognized       |       | —                             |       | 351,000 |   |
| Less: total stock-based compensation (1)       |       | (430,000                           | )          | (608,000 | ) |
|                                           |       |                               |       |   |   |
| Net loss, as adjusted                          |       | $                                  | (4,079,000 | ) | $ | (4,187,000 | ) |
|                                           |       |                               |       |   |   |
| Basic and diluted loss per share, as  reported |       | $                                  | (0.22      | ) | $ | (0.38 | ) |
| Basic and diluted loss per share, as  adjusted |       | $                                  | (0.25      | ) | $ | (0.41 | ) |

 

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**(1) As determined under thefair value method.**

 

**The Company uses the Black-Scholes option-pricing model forestimating the fair value of options granted. The Black-Scholes option-pricingmodel was developed for use in estimating the fair value of traded options thathave no vesting restrictions and are fully transferable.  In addition, option valuation models requirethe input of highly subjective assumptions, including the expected stock pricevolatility.  The Company uses projectedvolatility rates, which are based upon historical volatility rates, trendedinto future years. Because the Company’s employee stock options havecharacteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management’s opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of the Company’soptions. For purposes of pro forma disclosures, the estimated fair values ofthe options are amortized over the options’ vesting periods.**

** **

*RevenueRecognition*

* *

The Company sells products for the radiation oncologycommunity, including intensity modulated radiation therapy (“IMRT”) and imageguided radiation therapy (“IGRT”) products and services, as well asbrachytherapy seeds used in the treatment of cancer.  Product revenue consists of brachytherapy,non-therapeutic sources, certain IMRT hardware devices and software productsincluding IMRT treatment planning and delivery systems and our IGRTsystem.  Service revenue consists ofwarranty revenue from product sales and maintenance service agreements.

 

7

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Product revenue

 

The Company applies the provisions of SEC StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition” for the sale ofnon-software products.  SAB 104 whichsupersedes SAB No. 101, “Revenue Recognition in Financial Statements”, providesguidance on the recognition, presentation and disclosure of revenue infinancial statements.  SAB No. 104outlines the basic criteria that must be met to recognize revenue and providesguidance for the disclosure of revenue recognition policies.  In general, the Company recognizes revenuerelated to product sales when (i) persuasive evidence of an arrangement exists,(ii) delivery has occurred, (iii) the fee is fixed or determinable, and (iv)collectibility is reasonably assured.

 

Revenue recognition is deferred when undeliveredproducts or services are essential to the functionality of delivered products,customer acceptance is uncertain, significant obligations remain, or the fairvalue of undelivered elements is unknown or collectibility is uncertain.

 

The Company’s software product revenue is generatedfrom the sale of advanced medical equipment products.  The software element of the Company’sproducts is deemed an essential element of the functionality of theproduct.  Maintenance and support areprovided with the initial product sale for a twelve month period.  The maintenance and support is renewableannually or longer, at the customer’s discretion.

 

The Company recognizes software revenue in accordancewith the provisions of Statement of Position 97-2 (“SOP 97-2”), “SoftwareRevenue Recognition”, as amended by Statement of Position 98-9 (“SOP 98-9”), “Modificationof SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions”.  Under the provisions of SOP 97-2, the Companyrecognizes software revenue upon delivery and acceptance, provided allsignificant obligations have been met, persuasive evidence of an arrangementexists, fees are fixed or determinable, collection is probable, and the Companyis not involved in providing services that are essential to the functionalityof the product.

 

The Company’s software sales are generally multipleelement arrangements, which could include the product, first year annualmaintenance and support, and training and installation.  Revenues from the multiple elementsarrangements are allocated to each element based on the relative fair value ofthe elements.  If the fair value of theelement exists, the determination is based on vendor specific objectiveevidence.  If such evidence of fair valuefor each element of the arrangement does not exist, all revenue from thearrangement is deferred until such time that evidence of fair value of eachelement does exist or until all elements of the arrangement are delivered.  If in a multiple element arrangement, fairvalue does not exist for one or more of the undelivered elements, the residualmethod of accounting is applied.  Underthe residual method, the fair value of the undelivered elements is deferred,and the remaining portion of the arrangement fee is recognized as revenue.

 

Service Revenue

 

Services revenues are derived mainly from maintenanceand support contracts and are recognized on a straight-line basis over the termof the contract. Payments for maintenance revenues are normally received inadvance and are nonrefundable.

 

8

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*Recent AccountingPronouncements*

* *

In December 2004, the FASB issuedSFAS No. 123 (Revised 2004), “Share-Based Payment,” that addresses theaccounting for share-based payment transactions in which a Company receives employeeservices in exchange for (a) equity instruments of the Company or (b)liabilities that are based on the fair value of the Company’s equityinstruments or that may be settled by the issuance of such equity instruments.SFAS No. 123R addresses all forms of share-based payment awards, includingshares issued under employee stock purchase plans, stock options, restrictedstock and stock appreciation rights. SFAS No. 123R eliminates the ability toaccount for share-based compensation transactions using APB Opinion No. 25, “Accountingfor Stock Issued to Employees”, that was provided in Statement 123 asoriginally issued. Under SFAS No. 123R companies are required to recordcompensation expense for all share based payment award transactions measured atfair value. This statement is effective for quarters ending after June 15,2005. The Company has not yet determined the impact of applying the variousprovisions of SFAS No. 123R.  Currentlythe Company uses the Black-Scholes option pricing model to estimate the fairvalue of stock options granted to employees and is evaluating option valuationmodels including the Black-Scholes to determine which model the Company willuse upon the adoption of SFAS 123R.

 

In November 2004, the FASB issuedSFAS No. 151 “Inventory Costs”. This Statement amends the guidance in ARB No.43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs,  and wastedmaterial (spoilage).  In addition,  this Statement requires that allocation offixed production overhead to the costs of conversion be based on the normalcapacity of the production facilities. The provisions of this Statement will beeffective for the Company beginning with its fiscal year ending 2005. TheCompany is currently evaluating the impact of this new standard, but believesthat it will not have a material impact on the Company’s financial position,results of operations or cash flows.

 

In December 2004, the FASB issuedSFAS No. 153 “Exchanges of Non-monetary Assets - an amendment of APB OpinionNo. 29.”  This Statement amended APBOpinion No. 29 to eliminate the exception for non-monetary exchanges of similarproductive assets and replaces it with a general exception for exchanges ofnon-monetary assets that do not have commercial substance. A non-monetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange. The Company iscurrently evaluating the impact of this new standard, but believes that it willnot have a material impact upon the Company’s financial position, results ofoperations or cash flows.

 

**NOTE 2**– **VARIABLE INTEREST ENTITY**

 

In October 2003, the Company entered into aSecured Loan Agreement with Prostate Centers of America (“PCA”).  Underthe agreement, the Company was obligated to make periodic advances subject toPCA achieving certain milestones.

 

As of January 31, 2005, the Company’s advances to PCA totaledapproximately $1.0 million. The secured note bears interest at 6% per annum andis repayable in four installments commencing on December 1, 2004, with allunpaid principal and interest due on September 1, 2005. To date, nopayments have been received and the Company is uncertain when or whether the loanwill be repaid. As of January 31, 2005, the Company has expensed an amountequal to the amount advanced. The Company has no equity interest in PCA. Thefunds are to be used for general working capital to provide variousbrachytherapy services to ambulatory surgical centers. A distributor who hasagreed to procure all of its brachytherapy seeds exclusively from the Companythrough October 2008, has a majority interest in PCA. Based on the terms of thelending and supply agreements with the above entities, the Company determinedthat PCA is a variable interest entity (“VIE”) and the Company is the primarybeneficiary under FIN No. 46 since PCA does not have sufficient equity atrisk for the entity to finance its activities.

 

9

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FIN No. 46 requires that an enterprise consolidate a VIE if thatenterprise has a variable interest that will absorb a majority of the entity’sexpected losses if they occur. Accordingly, the Company adopted FIN No. 46in October 2003 and consolidated PCA as a VIE, regardless of the Companynot having an equity interest in PCA and its creditors having no recourseagainst the Company.  The Companyconsolidated PCA in its Radiation Sources segment, to the extent of the Company’sloan of approximately $1.0 million.

 

Included in the Company’s consolidated balance sheet at January 31,2005, and October 31, 2004 were the following net assets of PCA:

 
| ** **                           | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|--------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                           | ** ** | **2005**        | ** ** | **2004**        | ** ** |
|                                 | ** ** | ** **      |       |            |       |
| Cash                                 |       | $               | 144,000    |            | $          | 473,000 |   |
| Accounts receivable                  |       | 55,000          |       | 52,000          |       |
| Prepaid and other current assets     |       | 11,000          |       | 10,000          |       |
| Equipment and leasehold improvements |       | 384,000         |       | 555,000         |       |
| Other assets                         |       | 33,000          |       | 33,000          |       |
| Accounts payable                     |       | (115,000        | )          | (389,000        | )          |
| Accrued expenses                     |       | (512,000        | )          | (717,000        | )          |
| ** **                           | ** ** | ** **      |       |            |       |
| Net assets                           |       | $               | —     |            | $          | 17,000 |   |

 

Consolidation of PCA’s results of operations included the following:

 
| ** **  | ** ** | **Three months ended January 31,** | ** ** |
|-------------|------------|------------------------------------|------------|
| ** **  | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|        |       |                               |       |   |   |
| Net revenue |       | $                                  | —     |   | $ | — |   |
|        |       |                               |       |   |   |
| Net loss    |       | (18,000                            | )          | (42,000 | ) |
|             |            |                                    |            |  |  |  |  |

 

**NOTE 3 – MARKETABLESECURITIES**

** **

**The Company invests excess cash in marketable securitiesconsisting primarily of commercial paper, corporate notes and bonds, U.S.Government securities and money market funds.**

** **

**Debt securities that the Company has the positive intentand ability to hold to maturity are classified as “held-to-maturity” andreported at amortized cost. Debt securities not classified as held-to-maturityand marketable equity securities are classified as “available-for-sale,” arerecorded at fair value with unrealized gains and losses included instockholders’ equity.**

** **

**The Company continually reviews its investments todetermine whether a decline in fair value below the cost basis is other thantemporary. If the decline in fair value is judged to be other than temporary,the cost basis of the security is written down to fair value and the amount ofthe write-down is included in the Consolidated Statements of Operations.**

 

10

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**NOTE 4 – ACCOUNTSRECEIVABLE**

** **

Accounts receivable consist of the following:

 
| ** **                            | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|---------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                            | ** ** | **2005**        | ** ** | **2004**        | ** ** |
| ** **                            | ** ** | ** **      |       |            |       |
| Accounts receivables                  |       | $               | 6,454,000  |            | $          | 7,757,000 |   |
| Less: allowance for doubtful accounts |       | (625,000        | )          | (625,000        | )          |
| ** **                            | ** ** | ** **      |       |            |       |
|                                  |       | $               | 5,829,000  |            | $          | 7,132,000 |   |

 

**NOTE 5 – INVENTORIES**

** **

**Inventories are valued at the lower of cost or market asdetermined under the first-in, first-out method. Costs include materials, laborand manufacturing overhead. Inventories are shown net of applicable reservesand allowances. Inventories consist of the following:**

 
| ** **      | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|-----------------|------------|-----------------|------------|-----------------|------------|
| ** **      | ** ** | **2005**        | ** ** | **2004**        | ** ** |
|            |       |            |       |            |       |
| Raw materials   |       | $               | 3,971,000  |            | $          | 4,249,000 |   |
| Work in process |       | 67,000          |       | 47,000          |       |
| Finished goods  |       | 371,000         |       | 575,000         |       |
|            |       |            |       |            |       |
|            |       | $               | 4,409,000  |            | $          | 4,871,000 |   |

** **

**NOTE 6 – NET LOSS PERSHARE**

** **

Basic earnings (loss) per share is computed bydividing the net income (loss) by the weighted average number of sharesoutstanding for the period. Diluted earnings (loss) per share is computed bydividing the net income (loss) by the sum of the weighted average number ofcommon shares outstanding for the period plus the assumed exercise of alldilutive securities by applying the treasury stock method unless such assumedexercises are anti-dilutive. The following table sets forth the computation ofbasic and diluted earnings (loss) per share:

 
| ** **                                    | ** ** | **Three months ended January 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Net loss                                      |       | $                                  | (3,649,000 | ) | $ | (3,930,000 | ) |
|                                          |       |                               |       |   |   |
| Weighted average shares outstanding - basic   |       | 16,256,775                         |       | 10,283,237 |   |
| Dilutive effect of stock options              |       | —                             |       | — |   |
|                                          |       |                               |       |   |   |
| Weighted average shares outstanding - diluted |       | 16,256,775                         |       | 10,283,237 |   |
|                                          |       |                               |       |   |   |
| Basic loss per share                          |       | $                                  | (0.22      | ) | $ | (0.38 | ) |
| Diluted loss per share                        |       | $                                  | (0.22      | ) | $ | (0.38 | ) |

 

Stock options to purchase 3,158,522 and 2,634,322common shares for the three months ended January 31, 2005, and 2004,respectively, were not included in the computation of diluted earnings pershare because their effect would have been anti-dilutive.

 

11

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**NOTE 7 – ACQUISITION**

** **

In May 2004, the Company acquired NOMOS Corporation (“NOMOS”).The results of NOMOS have been included in the consolidated financialstatements from the date of acquisition as the Company’s IMRT/IGRT businesssegment. NOMOS develops, markets and sells medical devices used in externalbeam radiation. As a result of the acquisition, the Company has expanded itsproduct line, which the Company believes should allow it to compete moreeffectively in the radiation oncology market.

 

The purchase price of approximately $58 millionconsisted of $11.5 million in cash, the issuance of 5.2 million shares of theCompany’s common stock with a fair value of approximately $37.3 million, theassumption of 1.4 million of stock options and warrants with a fair value of$4.6 million, direct transaction costs of $3.0 million and the assumption ofacquisition related liabilities of $1.6 million. The fair value of the commonstock used in determining the purchase price was $7.21 per share based on theaverage of the closing price of the common stock for the period two days beforeand after the October 27, 2003 merger agreement announcement date. Thestock options and warrants, which fully vested at the acquisition date, werevalued using a Black-Scholes valuation model with the following assumptions:risk-free interest rate of 4.5%, volatility factor of 60%, expected term of1.5 years for stock options, contractual term of 0.5 years forwarrants and no dividend yield. The acquisition was accomplished through areverse triangular merger into a wholly owned subsidiary of the Company, and isreflected in the Company’s financial statements, including the footnotesthereto, as the IMRT/IGRT operating segment.

 

The following table presents unaudited pro formarevenue, net loss and loss per share giving the effect of NOMOS acquisition asif it had been completed at the beginning of each period presented:

** **
| ** **                            | ** ** | **Three months ended January 31,** | ** ** |
|---------------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **2005**                           | ** ** | **2004** | ** ** |
|                                  |       |                               |       |   |   |
| Revenue                               |       | $                                  | 8,164,000  |   | $ | 7,604,000 |   |
|                                  |       |                               |       |   |   |
| Net loss                              |       | (3,649,000                         | )          | (12,249,000 | ) |
|                                  |       |                               |       |   |   |
| Net loss per share, basic and diluted |       | (0.22                              | )          | (0.79 | ) |
|                                       |            |                                    |            |  |  |  |  |

 

The unaudited pro forma financial information abovereflects the Company’s changes in revenue recognition policy. Prior to theacquisition by the Company, NOMOS had recognized revenue of the BAT productunder SAB No. 101 as a product in which software was deemed incidental.The Company has determined that revenue recognition of the BAT product shouldbe accounted for under SOP 97-2. The Company also determined that revenue recognitionof the BAT product should be deferred from the time of shipment, as NOMOS hadhistorically recognized revenue, to the time of acceptance or installation. Asa result of these changes in revenue recognition, the Company has presented thepro forma information above to be consistent with results presented for thethree months ended January 31, 2005.

 

12

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**NOTE 8**– **INTANGIBLE ASSETS**

 
| ** **                      | ** ** | **January 31, 2005**        | ** ** | **October 31, 2004**          | ** ** |
|---------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortizable intangible assets   |       |                        |       |                          |       |   |   |   |   |
| Purchased technology            |       | $                           | 24,232,000 |                          | $          | 1,318,000 |   | $ | 24,232,000 |   | $ | 884,000 |   |
| Existing customer relationships |       | 1,952,000                   |       | 178,000                       |       | 1,952,000 |   | 120,000 |   |
| Trademark                       |       | 4,426,000                   |       | 248,000                       |       | 4,426,000 |   | 167,000 |   |
| Patents and licenses            |       | 98,000                      |       | 35,000                        |       | 98,000 |   | 33,000 |   |
|                            |       |                        |       |                          |       |   |   |   |   |
|                            |       | $                           | 30,708,000 |                          | $          | 1,779,000 |   | $ | 30,708,000 |   | $ | 1,204,000 |   |

 

Amortization expense was $575,000 and $11,000 for the three monthsended January 31, 2005 and 2004, respectively.

 

The estimate of aggregate amortization expense for the subsequent yearsis as follows:

 
| **For the Years Ended January 31,** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|
| ** **                          | ** ** | ** ** | ** ** |
| 2006                                |       | $          | 2,320,000  |   |
| 2007                                |       | 2,344,000  |       |
| 2008                                |       | 2,330,000  |       |
| 2009                                |       | 2,300,000  |       |
| 2010                                |       | 2,272,000  |       |
| Thereafter                          |       | 17,363,000 |       |
|                                |       |       |       |
|                                |       | $          | 28,929,000 |   |

 

13

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**NOTE 9**– DISCONTINUED OPERATION

** **

In September 2004, the Company shut-down its Theseusoperation.  Effective with the fourth quarterof 2004, this segment is reflected as a discontinued operation. All priorperiod results have been restated accordingly, including the reallocation offixed overhead charges to other business segments.

 

Revenues and loss from the discontinued operation wereas follows:

 
| ** **  | ** ** | **Three months ended January 31,** | ** ** |
|-------------|------------|------------------------------------|------------|
| ** **  | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **  | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Net revenue |       | $                                  | —     |   | $ | — |   |
|        |       |                               |       |   |   |
| Net loss    |       | $                                  | —     |   | $ | (1,529,000 | ) |

** **

Assets and liabilities of the discontinued operationswere as follows:

 
| ** **                                          | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                          | ** ** | **2005**        | ** ** | **2004**        | ** ** |
|                                                |       |            |       |            |       |
| Cash                                                |       | $               | —     |            | $          | 186,000 |   |
| Other assets                                        |       | 16,000          |       | 16,000          |       |
| Accounts payable                                    |       | (3,000          | )          | (45,000         | )          |
| Accrued expenses                                    |       | (888,000        | )          | (1,516,000      | )          |
|                                                |       |            |       |            |       |
| Net assets (liabilities) of discontinued  operation |       | $               | (875,000   | )               | $          | (1,359,000 | ) |

 

**NOTE  10 – SEGMENT INFORMATION**

** **

**The Company operates two segmentsbased upon a combination of factors including: product produced, manufacturingprocess and management oversight. Radiation Sources develops and market radioisotopic products includingbrachytherapy seeds, accessories and calibration sources used in the treatmentof disease and used in medical, environmental, research and industrialapplications.  IMRT/IGRT develops andmarkets products using external beam radiation therapy for the treatment ofdisease.**

** **

**The Company evaluates performanceand allocates resources based upon operating results and developmentmilestones.  The accounting polices ofthe reportable segments are the same as those described in Note 1 in the summaryof significant accounting policies. There are no inter-company sales or profits.**

 

14

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**The Company’s segments arebusiness units that either offer different products or are managed separatelybecause they operate with distinct manufacturing and development processes.**

** **
| ** **               | ** ** | **Three months ended January 31,** | ** ** |
|--------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| ** **               |       |                               |       |   |   |
| **Revenues**             |       |                               |       |   |   |
| IMRT/IGRT                |       | $                                  | 5,336,000  |   | $ | — |   |
| Radiation Sources        |       | 2,828,000                          |       | 3,363,000 |   |
|                     |       |                               |       |   |   |
|                     |       | $                                  | 8,164,000  |   | $ | 3,363,000 |   |
|                     |       |                               |       |   |   |
| **Loss from Operations** |       |                               |       |   |   |
| IMRT/IGRT                |       | $                                  | (2,637,000 | ) | $ | — |   |
| Radiation Sources        |       | (1,081,000                         | )          | (2,612,000 | ) |
|                     |       |                               |       |   |   |
|                     |       | $                                  | (3,718,000 | ) | $ | (2,612,000 | ) |

** **
| ** **             | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|------------------------|------------|-----------------|------------|-----------------|------------|
| ** **             | ** ** | **2005**        | ** ** | **2004**        | ** ** |
|                   |       |            |       |            |       |
| **Goodwill**           |       |            |       |            |       |
| IMRT/IGRT              |       | $               | 18,525,000 |            | $          | 18,525,000 |   |
| Radiation Sources      |       | 207,000         |       | 207,000         |       |
| Discontinued operation |       | —          |       | —          |       |
|                   |       |            |       |            |       |
|                   |       | $               | 18,732,000 |            | $          | 18,732,000 |   |
|                   |       |            |       |            |       |
| **Total assets**       |       |            |       |            |       |
| IMRT/IGRT              |       | $               | 62,894,000 |            | $          | 61,719,000 |   |
| Radiation Sources      |       | 11,668,000      |       | 18,608,000      |       |
| Discontinued operation |       | 16,000          |       | 212,000         |       |
|                   |       |            |       |            |       |
|                   |       | $               | 74,578,000 |            | $          | 80,539,000 |   |

 

15

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**Item 2.**        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

** **

The following discussion and analysis providesinformation, which our management believes is relevant to an assessment andunderstanding of our financial condition and results of operations. Thediscussion should be read in conjunction with the Consolidated FinancialStatements contained herein and the notes thereto. Certain statements containedin this Form 10-Q, including, without limitation, statements containingthe words “believes”, “anticipates”, “estimates”, “expects”, “projections”, andwords of similar import are forward looking as that term is defined by: (i) thePrivate Securities Litigation Reform Act of 1995 (the “1995 Act”) and(ii) releases issued by the Securities and Exchange Commission (“SEC”).These statements are being made pursuant to the provisions of the 1995 Act andwith the intention of obtaining the benefits of the “Safe Harbor” provisions ofthe 1995 Act. We caution that any forward looking statements made herein arenot guarantees of future performance and that actual results may differmaterially from those in such forward looking statements as a result of variousfactors, including, but not limited to, any risks detailed herein or detailedfrom time to time in our other filings with the SEC including our most recentreport on Form 10-K. We are not undertaking any obligation to update publiclyany forward-looking statements. Readers should not place undue reliance onthese forward-looking statements.

 

**Overview**

** **

We manufacture, market and sell products for theradiation oncology community, including intensity modulated and image guidedradiation therapy products and services, as well as brachytherapy seeds used inthe treatment of prostate cancer.  Ourbusiness is organized into two operating segments: IMRT/IGRT and RadiationSources.  Theseus, which was discontinuedin September 2004, had been developing a radiopharmaceutical agent for themanagement of chemotherapy treatment.

 

IMRT/IGRT develops and markets intensity modulatedradiation therapy (“IMRT”) and image guided radiation therapy (“IGRT”) productsused in external beam radiation therapy for the treatment of disease. RadiationSources develops and markets radioisotopic products including brachytherapyseeds, accessories and calibration sources used in the treatment of disease andused in medical, environmental, research and industrial applications.

 

In May 2004, we acquired NOMOS Corporation (“NOMOS”).NOMOS was a privately held developer, manufacturer, and marketer of IMRT andIGRT products and services.  Under theterms of the merger agreement, we issued approximately 5.2 million shares ofour common stock and paid cash of approximately $11.5 million, in exchange forall of the outstanding capital stock of NOMOS. We manage this business as our IMRT/IGRT operating segment. Our resultsof operations, cash flows and balance sheet for the three months ended January31, 2005 include the results of NOMOS versus none in the three months endedJanuary 31, 2004.  We expect to see ourrevenue, gross profit and operating expenses to increase throughout the fiscalyear as result of the acquisition of NOMOS.

 

In September 2004, we shut down our Theseus Imagingsubsidiary (“Theseus”).  We had acquiredTheseus in October 2000 to develop a proprietary radiopharmaceuticalagent.  For comparison purposes, theresults of operation for Theseus have been presented as a discontinuedoperation.

 

16

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**Resultsof Operations**

** **

**Three Months EndedJanuary 31, 2005 Compared to Three Months Ended January 31, 2004**

** **

**Revenue**.  Revenueincreased $4.8 million, or 143%, to $8.2 million for the three months endedJanuary 31, 2005, from $3.4 million for the three months ended January 31,2004.  The increase in revenue during thequarter ended January 31, 2005, is attributed to the acquisition of ourIMRT/IGRT business in May 2004 ($5.3 million) offset by a decrease in RadiationSources revenues ($0.5 million).

 

Product revenue increased $2.0 million, or 60% to $5.4million for the three months ended January 31, 2005, from $3.4 million for thethree months ended January 31, 2004.  Theincrease in product revenue during the quarter ended January 31, 2005, isattributed to the acquisition of our IMRT/IGRT business ($2.5 million) offsetby a decrease in Radiation Sources revenues ($0.5 million).  The decline in Radiation Sources is due to adecline in unit volume.  During thisperiod the average selling price of our Radiation Sources’ products remainedconstant. We anticipate improvement in unit volume during the year as werealign our sales force according to product lines and continue to pursuenational accounts.

 

Service revenue increased $2.8 million for the threemonths ended January 31, 2005 from none for the three months ended January 31,2004 due to the acquisition of NOMOS.

 

**Gross profit**.  Gross profitincreased $1.4 million, or 101%, to $2.9 million for the three months endedJanuary 31, 2005, from $1.5 million for the three months ended January 31,2004.  Gross profit as a percentage ofrevenues decreased from 43% to 36% during this period.  The increase in gross profit is attributed tothe acquisition of our IMRT/IGRT business ($2.2 million) offset by a decreasein Radiation Sources ($0.7 million).

 

Gross profit for the three months ended January 31,2005 consists of $2.2 million, or 41% of revenue from our IMRT/IGRT businessand $0.7 million or 22% of revenue from our Radiation Sources business.

 

The decrease in gross profit of Radiation Sources isattributed to (i) a decrease in unit volume of brachytherapy seeds and otherradiation sources, (ii) an increase in fixed overhead costs and (iii) anincrease in low margin ancillary services that are outsourced.  Our manufacturing process has relatively highfixed costs and therefore our margins are very sensitive to changes in volume.

 

**Selling Expenses**.  Sellingexpenses include salaries, commissions and other related costs associated withour sales and marketing personnel and advertising, trade shows and otherpromotional programs. Selling expenses increased $1.3 million, or 175% to $2.1million for the three months ended January 31, 2005, from $0.8 million for thethree months ended January 31, 2004.  Theincrease in selling expenses is primarily attributed to the marketing costsassociated with the acquisition of our IMRT/IGRT business.

 

**General and administrative expenses**. General and administrative (“G&A”) expenses include salaries andother related costs associated with finance, executive, human resources andinformation technology personnel and other administrative costs. G&Aexpenses decreased $0.8 million, or 26%, to $2.3 million for the three monthsended January 31, 2005, from $3.1 million for the three months ended January31, 2004. The decrease is primarily attributed to the inclusion of $1.0 millionseverance paid to a former officer of the Company in the quarter ended January31, 2004, offset by additional administrative costs associated with theacquisition of the IMRT/IGRT business.

 

17

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**Research and development**. Research and development (“R&D”) expenses include salaries and otherrelated costs associated with product development, third party developmentcosts, overhead costs and material used in development of prototypes. OurR&D costs increased $1.4 million, or 883%, to $1.6 million for the threemonths ended January 31, 2005, from $0.2 million for the three months endedJanuary 31, 2004.  The increase isprimarily attributed to the acquisition of our IMRT/IGRT business.

 

**Amortization of intangible assets**. Amortization of intangible assets increased to $0.6 million for the threemonths ended January 31, 2005 from $11,000 for the three months ended January31, 2004.  The increase is attributed tothe amortization of purchased intangibles acquired in the purchase of NOMOS.

 

**Interest and other income, net.** Interest and other income decreased $0.1 million, or 68%, to $0.1million for the three months ended January 31, 2005, from $0.2 million for thethree months ended January 31, 2004. The decrease is attributed to a smallerportfolio of marketable securities.

 

**Liquidity and Capital Resources**

** **

The accompanying financial statements have beenprepared on a going concern basis, which contemplates the realization of assetsand liquidation of liabilities in the normal course of business. However, wehave continued to incur substantial net losses and to use substantial amountsof cash.

 

We believe that our existing cash resources andforecasted operating cash flow under our current operating plan will besufficient to meet our working capital requirements for at least the nexttwelve months. Our plan is to return to profitability and to generate positivecash flows by increasing revenues from existing and new products and services,realizing the benefits of the integration of the historic company and NOMOSoperations and a focus on cost control. However, there is no assurance that wewill be successful with these plans. If events and circumstances occur suchthat we do not meet our current operating plan as expected, and we are unableto raise additional financing, we may be required to further reduce certaindiscretionary spending, which could have a material adverse effect on ourability to achieve our intended business objectives. We expect that we will beable to satisfy our longer term liquidity needs for research and development,capital expenditures, and acquisitions through a combination of cash generatedby operations, future public offerings and private placements of our commonstock, and bank lines of credit.

 

At January 31, 2005, we had cash, and cashequivalents, and investments in marketable securities aggregating approximately$11.9 million, a decrease of approximately $3.1 million from $15.0 million atOctober 31, 2004. The decrease was primarily attributed to $2.7 million used incontinuing operations, $0.5 million used in discontinued operation and $0.1million used for capital expenditures, partially offset by $0.2 million in cashreceived from the exercise of stock options and the employee stock purchaseplan.

 

Cash flows used in operating activities decreased $1.3million or 29% to $3.2 million for the three months ended January 31, 2005 from$4.4 million for the three months ended January 31, 2004.  The decrease in cash used in operatingactivities reflects a reduction of cash used in our discontinued operation($2.0 million) offset by payment of accounts payable and accrued expenses. Weexpect that cash used in operating activities may fluctuate in future periodsas a result of a number of factors, including fluctuations in our operatingresults, accounts receivable collections, inventory management, research anddevelopment expenses, and the timing of payments.

 

Cash flows provided by investing activities decreased$2.6 million or 53% to $2.3 million for the three months ended January 31,2005, from $4.9 million for the three months ended January 31, 2004.  The decrease reflects a reduction in need todraw down our balance of marketable securities to fund operations ($2.4million) and a decrease in spending on capital expenditures ($0.1 million).

 

18

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Cash provided by financing activities decreased $0.3million or 56% to $0.2 million for the three months ended January 31, 2005,from $0.5 million for the three months ended January 31, 2004.  The decrease reflects a reduction in theproceeds from exercise of employee stock options.

 

We have $4.3 million in operating lease obligationsfor facilities and equipment under non-cancelable operating lease agreements.We have also entered into purchase commitments to suppliers under blanketpurchase orders in the amount of $0.5 million.

 

**CriticalAccounting Policies**

** **

The preparation of financial statements and relateddisclosures in conformity with accounting principles generally accepted in theUnited States of America requires management to make judgments, assumptions andestimates that affect the amounts reported in the Consolidated FinancialStatements included in the Company’s Form 10-K for the year ended October 31,2004, and accompanying notes. Note 1 to the Consolidated Financial Statementsdescribes the significant accounting policies and methods used in thepreparation of the Consolidated Financial Statements. Estimates are used for,but not limited to, the accounting for revenue recognition, allowance fordoubtful accounts, goodwill and long-lived asset impairments, losscontingencies, and taxes. Estimates and assumptions about future events andtheir effects cannot be determined with certainty. We base our estimates onhistorical experience and on various other assumptions believed to beapplicable and reasonable under the circumstances. These estimates may changeas new events occur, as additional information is obtained and as our operatingenvironment changes. These changes have historically been minor and have beenincluded in the consolidated financial statements as soon as they became known.The following critical accounting policies are impacted significantly byjudgments, assumptions and estimates used in the preparation of theConsolidated Financial Statements and actual results could differ materiallyfrom the amounts reported based on these policies.

 

*Revenue Recognition*

 

Wesell products for the radiation oncology community, including IMRT and IGRTproducts and services, as well as brachytherapy seeds used in the treatment ofcancer.  Product revenue consists of brachytherapy, non-therapeuticsources, certain IMRT hardware devices and software products including IMRTtreatment planning and delivery systems and our IGRT system.  Service revenue consists of warranty revenuefrom product sales and maintenance service agreements.

 

Productrevenue

 

We apply the provisions of SEC StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition” for the sale ofnon-software products.  SAB No. 104 which supersedes SAB No. 101, “RevenueRecognition in Financial Statements”, provides guidance on the recognition,presentation and disclosure of revenue in financial statements.  SAB No.104 outlines the basic criteria that must be met to recognize revenue andprovides guidance for the disclosure of revenue recognition policies.  Ingeneral, we recognize revenue related to product sales when (i) persuasiveevidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee isfixed or determinable, and (iv) collectibility is reasonably assured.

 

Revenue recognition is deferred whenundelivered products or services are essential to the functionality ofdelivered products, customer acceptance is uncertain, significant obligationsremain, or the fair value of undelivered elements is unknown or collectibilityis uncertain.

 

Our software product revenue isgenerated from the sale of advanced medical equipment products.  Thesoftware element of our products is deemed an essential element of thefunctionality of the product.  

 

19

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Maintenance and support are providedwith the initial product sale for a twelve month period.  The maintenanceand support is renewable annually or longer, at the customer’s discretion.

 

We recognize software revenue inaccordance with the provisions of Statement of Position 97-2 (“SOP 97-2”), “SoftwareRevenue Recognition”, as amended by Statement of Position 98-9 (“SOP 98-9”), “Modificationof SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions”. Under the provisions of SOP 97-2, we recognize software revenue upon deliveryand acceptance, provided all significant obligations have been met, persuasiveevidence of an arrangement exists, fees are fixed or determinable, collectionis probable, and we are not involved in providing services that are essentialto the functionality of the product.

 

Oursoftware sales are generally multiple element arrangements, which could includethe product, first year annual maintenance and support, and training andinstallation.  Revenues from the multiple element arrangements areallocated to each element based on the relative fair value of theelements.  If the fair value of the element exists, the determination isbased on vendor specific objective evidence.  If such evidence of fairvalue for each element of the arrangement does not exist, all revenue from thearrangement is deferred until such time that evidence of fair value of eachelement does exist or until all elements of the arrangement are delivered. If in a multiple element arrangement, fair value does not exist for one or moreof the undelivered elements, the residual method of accounting isapplied.  Under the residual method, the fair value of the undeliveredelements is deferred, and the remaining portion of the arrangement fee isrecognized as revenue.

 

Servicerevenue

 

Servicerevenues are derived mainly from maintenance and support contracts and arerecognized on a straight-line basis over the term of the contract. Payments formaintenance revenues are normally received in advance and are nonrefundable.

 

*Allowance for Doubtful Accounts and Sales Returns*

 

The allowance for doubtful accountsis based on our assessment of the collectibility of specific customer accountsand the aging of the accounts receivable. We regularly review the allowance byconsidering factors such as historical experience, age of the accountsreceivable balances and current economic conditions that may affect a customer’sability to pay. If there was a deterioration of a major customer’s creditworthiness or actual defaults are higher than our historical experience, ourestimates of the recoverability of amounts due us could be overstated whichcould have an adverse impact on our financial results.

 

A reserve for sales returns isestablished based on historical trends in product return rates and is recordedas a reduction of our accounts receivable. If the actual future returns were todeviate from the historical data on which the reserve had been established, ourrevenue could be adversely affected. To date, product returns have not beenconsidered material to our results of operations.

 

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*Goodwill and Other Intangible Assets*

 

SFASNo. 142, “Goodwill and Other Intangible Assets”, requires that goodwill betested for impairment at the reporting unit level (operating segment or onelevel below an operating segment) on an annual basis (August 31st) and betweenannual tests if an event occurs or circumstances change that would more likelythan not reduce the fair value of a reporting unit below its carrying value.These events or circumstances could include a significant change in thebusiness climate, legal factors, operating performance indicators, competition,sale or disposition of a significant portion of a reporting unit. Applicationof the goodwill impairment test requires judgment, including the identificationof reporting units, assignment of assets and liabilities to reporting units,assignment of goodwill to reporting units, and determination of the fair valueof each reporting unit. The fair value of each reporting unit is estimatedusing a discounted cash flow methodology. This requires significant judgmentsincluding estimation of future cash flows, which is dependent on internalforecasts, estimation of the long-term rate of growth for our business, theuseful life over which cash flows will occur, and determination of our weightedaverage cost of capital. Changes in these estimates and assumptions couldmaterially affect the determination of fair value and/or goodwill impairmentfor each reporting unit.

 

*Researchand Development Costs*

 

We account for research anddevelopment costs in accordance with several accounting pronouncements,including SFAS No. 2, “Accounting for Research and Development Costs,” and SFASNo. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, orOtherwise Marketed.” SFAS No. 86 specifies that costs incurred internally inresearching and developing a computer software product should be charged toexpense until technological feasibility has been established for the product.Once technological feasibility is established, all software costs should becapitalized until the product is available for general release to customers.Judgment is required in determining when technological feasibility of a productis established. We have determined that technological feasibility for oursoftware products is reached shortly before the products are released tomanufacturing. Costs incurred after technological feasibility is establishedare not material, and accordingly, we expense all research and developmentcosts when incurred.

 

*Loss Contingencies*

 

We record liabilities related topending litigation when an unfavorable outcome is probable and we canreasonably estimate the amount of the loss. We are subject to various legalproceedings and claims, either asserted or unasserted, that arise in theordinary course of business. We evaluate, among other factors, the degree ofprobability of an unfavorable outcome and an estimate of the amount of theloss. Significant judgment is required in both the determination of theprobability and as to whether an exposure can be reasonably estimated. When wedetermine that it is probable that a loss has been incurred, the effect isrecorded promptly in the consolidated financial statements. Although theoutcome of these claims cannot be predicted with certainty, we do not believethat any of our existing legal matters will have a material adverse effect onour financial condition or results of operations.

 

*Income Taxes*

 

We account for income taxes using theliability method. Deferred taxes are determined based on the differencesbetween the financial statement and tax bases of assets and liabilities, usingenacted tax rates in effect for the year in which the differences are expectedto reverse. Valuation allowances are established when necessary to reducedeferred tax assets to the amounts expected to be realized. In addition, we aresubject to examination of our income tax returns by the Internal RevenueService and other tax authorities. We regularly assess the likelihood ofadverse outcomes resulting from these examinations.

 

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**Recent Accounting Pronouncements**

** **

In December 2004, the FASB issuedSFAS No. 123 (Revised 2004), “Share-Based Payment,” that addresses theaccounting for share-based payment transactions in which a Company receivesemployee services in exchange for (a) equity instruments of the Company or (b)liabilities that are based on the fair value of the Company’s equityinstruments or that may be settled by the issuance of such equity instruments.SFAS No. 123R addresses all forms of share-based payment awards, includingshares issued under employee stock purchase plans, stock options, restrictedstock and stock appreciation rights. SFAS No. 123R eliminates the ability toaccount for share-based compensation transactions using APB Opinion No. 25, “Accountingfor Stock Issued to Employees”, that was provided in Statement 123 asoriginally issued. Under SFAS No. 123R companies are required to recordcompensation expense for all share based payment award transactions measured atfair value. This statement is effective for quarters ending after June 15,2005. We have not yet determined the impact of applying the various provisionsof SFAS No. 123R. Currently we use the Black-Scholes option pricing model toestimate the fair value of stock options granted to employees and areevaluating option valuation models including the Black-Scholes to determinewhich model we will use upon the adoption of SFAS 123R.

 

In November 2004, the FASB issuedSFAS No. 151 “Inventory Costs”. This Statement amends the guidance in ARB No.43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormalamounts of idle facility expense, freight, handling costs,  and wastedmaterial (spoilage).  In addition,  this Statement requires that allocation offixed production overhead to the costs of conversion be based on the normal capacityof the production facilities. The provisions of this Statement will beeffective for us beginning with our fiscal year ending 2005. We are currentlyevaluating the impact of this new standard, but we do not believe that it willhave a material impact on our financial position, results of operations or cashflows.

 

In December 2004, the FASB issuedSFAS No. 153 “Exchanges of Non-monetary Assets - an amendment of APB OpinionNo.  29”. This Statement amended APB Opinion No. 29 to eliminate the exception fornon-monetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of non-monetary assets that do not havecommercial substance. A non-monetary exchange has commercial substance if thefuture cash flows of the entity are expected to change significantly as aresult of the exchange. We are currently evaluating the impact of this newstandard, but we do not believe that it will have a material impact upon ourfinancial position, results of operations or cash flows.

 

###### **Item 3.**        Quantitativeand Qualitative Disclosures about Market Risk

###### ** **

Information about market risks forthe three months ended January 31, 2005, does not differ materially from thatdiscussed under Item 7A of the registrant’s Annual Report on Form 10-K for thefiscal year ended October 31, 2004.

 

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###### **Item4.**        Controls andProcedures

###### ** **

(a)  Evaluationof Disclosure Controls and Procedures

 

As required by Rule 13a-15(b) under theSecurities and Exchange Act of 1934 (the “Exchange Act”), we have carried outan evaluation, under the supervision and with the participation of ourmanagement, including our Chief Executive Officer (“CEO”) and our ChiefFinancial Officer (“CFO”), of the effectiveness, as of the end of the fiscalquarter covered by this report, of the design and operation of our “disclosurecontrols and procedures” as defined in Rule 13a-15(e) promulgated by theSEC under the Exchange Act. Based upon that evaluation, our CEO and our CFOconcluded that our disclosure controls and procedures, as of the end of suchfiscal quarter, were adequate and effective to ensure that information requiredto be disclosed by us in the reports that we file or submit under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the Commission’s rules and forms and that such information isaccumulated and communicated to our management, including our CEO and CFO, asappropriate to allow timely decisions regarding required disclosure.

 

(b)  Changes inInternal Controls

 

There has been no change in our internal control overfinancial reporting during the quarter ended January 31, 2005, that hasmaterially affected or is reasonably likely to materially affect our internalcontrol over financial reporting.

 

**PART II –OTHER INFORMATION**

 

**TheCompany was not required to report the information pursuant to Items 1 through6 of Part II of Form 10-Q except as follows:**

** **

## **Item 6.**           Exhibits

## ** **

(a)          Exhibits.

 
| **Exhibits No.** | ** ** | **Title**                                                                                                                        |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                             |
| 31.1             |       | Certification  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                             |
|             |       |                                                                                                                             |
| 31.2             |       | Certification  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002                             |
|             |       |                                                                                                                             |
| 32.1             |       | Certification  of Chief Executive Officer and Chief Financial Officer Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

** **

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|            | NORTH AMERICAN SCIENTIFIC, INC. |                   |
|-----------------|---------------------------------|------------------------|
|            |                            |                   |
|            |                            |                   |
| April 15,  2005 | By:                             | /s/ L.  Michael Cutrer |   |
|            |                            | Name:                  | L.  Michael Cutrer |   |
|            |                            | Title:                 | President  and |   |
|            |                            |                   | Chief  Executive Officer |   |
|            |                            |                   | (Principal  Executive Officer) |   |
|            |                            |                   |   |
|            |                            |                   |   |
| April 15,  2005 | By:                             | /s/ James W.  Klingler |   |
|            |                            | Name:                  | James  W. Klingler |   |
|            |                            | Title:                 | Senior Vice  President and |   |
|            |                            |                   | Chief  Financial Officer |   |
|            |                            |                   | (Principal  Financial Officer) |   |
|                 |                                 |                        |  |  |  |

 

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