**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**







**FORM
      10-Q**





x
      QUARTERLY REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF
      THE
      SECURITIES EXCHANGE ACT OF 1934





**For
      the quarterly period ended July 31, 2006**





or





o
      TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF
      THE
      SECURITIES EXCHANGE ACT OF 1934


Commission
      File Number 0-26670








**NORTH
      AMERICAN SCIENTIFIC, INC.**


(Exact
      name of registrant as specified in its charter)


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





20200
      Sunburst Street, Chatsworth, CA 91311


(Address
      of principal executive offices)





(818)
      734-8600


(Registrant's
      telephone number, including area code)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days. x Yes o No




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer” and “large accelerated filer” in Rule 12b-2 of the Securities
      Exchange Act of 1934. Large Accelerated Filer o Accelerated
      Filer x Non-Accelerated
      Filer o





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). o Yes x No





The
      number of shares of Registrant's Common Stock, $.01 par value, outstanding
      as of
      September 1, 2006 was 29,337,449 shares.















**NORTH
      AMERICAN SCIENTIFIC, INC.**




**Index**





**Page****Part
                I - Financial Information****Item
                1.**
            **Financial
                Statements**Consolidated
                Balance Sheets as of July 31, 2006 and October 31, 2005
            
            3Consolidated
                Statements of Operations for the three and nine months ended July
                31, 2006
                and 2005
            
            4Consolidated
                Statements of Cash Flows for the nine months ended July 31, 2006
                and
                2005
            
            5Condensed
                Notes to the Consolidated Financial Statements
            
            6**Item
                2.**
            **Management’s
                Discussion and Analysis of Financial Condition and **Results of
                Operations****
            
            22**Item
                3.**
            **Quantitative
                and Qualitative Disclosures about Market Risk**
            
            30**Item
                4.**
            **Controls
                and Procedures**
            
            30**Part
                II - Other Information****Item
                1.**
            **Legal
                Proceedings**
            
            31**Item
                1A.**
            **Risk
                Factors**
            
            32**Item
                4.**
            **Submission
                of Matters to a Vote of Security Holders**
            
            49**Item
                6.**
            **Exhibits**
            
            50**Signatures**
            
            51








-2-





**PART
      I - FINANCIAL INFORMATION**





**Item
      1. Financial Statements**




**NORTH
      AMERICAN SCIENTIFIC, INC.**




**Consolidated
      Balance Sheets**





**July
                31,**
            
            **October
                31,****2006**
            
            **2005**(Unaudited)**Assets**Current
                assetsCash
                and cash equivalents
            
            $
            4,417,000
            
            $
            2,630,000Marketable
                securities, held to maturity
            
            
            9,950,000
            
            
            993,000Accounts
                receivable, net of reserves
            
            
            5,370,000
            
            
            5,521,000Inventories,
                net of reserves
            
            
            3,858,000
            
            
            3,731,000Prepaid
                expenses and other current assets
            
            
            1,066,000
            
            
            794,000Total
                current assets
            
            
            24,661,000
            
            
            13,669,000Equipment
                and leasehold improvements, net of $6,211,000 and $5,522,000 accumulated
                depreciation at July 31, 2006 and October 31, 2005, respectively
            
            
            2,454,000
            
            
            2,836,000Goodwill
            
            
            2,564,000
            
            
            2,564,000Intangible
                assets, net of $3,975,000 and $3,505,000 accumulated amortization
                at July
                31, 2006 and October 31, 2005, respectively
            
            
            2,688,000
            
            
            3,158,000Other
                assets
            
            
            491,000
            
            
            106,000Total
                assets
            
            $
            32,858,000
            
            $
            22,333,000**Liabilities
                and Stockholders’ Equity**Current
                liabilitiesAccounts
                payable
            
            $
            1,695,000
            
            $
            2,164,000Accrued
                expenses
            
            
            4,037,000
            
            
            4,706,000Deferred
                revenue
            
            
            3,947,000
            
            
            4,662,000Total
                current liabilities
            
            
            9,679,000
            
            
            11,532,000Total
                liabilities
            
            
            9,679,000
            
            
            11,532,000Commitments
                and contingenciesStockholders’
                EquityPreferred
                  stock, $0.01 par value, 2,000,000 shares authorized; no sharesissued
            
            
            —
            
            
            —Common
                stock, $0.01 par value, 40,000,000 shares authorized, 29,445,475
                and
                17,056,669 shares issued; 29,337,449 and 16,948,643 shares outstanding
                as
                of July 31, 2006 and October 31, 2005, respectively
            
            
            298,000
            
            
            173,000Additional
                paid-in capital
            
            
            144,403,000
            
            
            121,147,000Treasury
                stock, at cost - 108,026 common shares
            
            
            (129,000
            )
            
            (129,000
            )Accumulated
                deficit
            
            
            (121,393,000
            )
            
            (110,390,000
            )Total
                stockholders’ equity
            
            
            23,179,000
            
            
            10,801,000Total
                liabilities and stockholders’ equity
            
            $
            32,858,000
            
            $
            22,333,000





See
      condensed notes to the consolidated financial statements.





-3-





**NORTH
      AMERICAN SCIENTIFIC, INC.**




**Consolidated
      Statements of Operations**


**(Unaudited)**


**Three
                    months ended July 31,**
                
                **Nine
                    months ended July 31,****2006**
                
                **2005**
                
                **2006**
                
                **2005**RevenueProduct
                
                $
                4,567,000
                
                $
                5,090,000
                
                $
                15,571,000
                
                $
                16,306,000Service
                
                
                2,530,000
                
                
                2,970,000
                
                
                7,110,000
                
                
                9,060,000Total
                    revenue
                
                
                7,097,000
                
                
                8,060,000
                
                
                22,681,000
                
                
                25,366,000Cost
                    of revenueProduct
                
                
                3,565,000
                
                
                3,056,000
                
                
                11,610,000
                
                
                11,886,000Service
                
                
                1,048,000
                
                
                1,621,000
                
                
                2,810,000
                
                
                3,511,000Total
                    cost of revenue
                
                
                4,613,000
                
                
                4,677,000
                
                
                14,420,000
                
                
                15,397,000Gross
                    profit
                
                
                2,484,000
                
                
                3,383,000
                
                
                8,261,000
                
                
                9,969,000Operating
                    expensesSelling
                    expenses
                
                
                2,039,000
                
                
                2,145,000
                
                
                6,224,000
                
                
                6,453,000General
                    and administrative expenses
                
                
                3,526,000
                
                
                2,445,000
                
                
                8,337,000
                
                
                8,018,000Research
                    and development
                
                
                1,311,000
                
                
                1,543,000
                
                
                4,051,000
                
                
                4,799,000Amortization
                    of intangible assets
                
                
                157,000
                
                
                575,000
                
                
                471,000
                
                
                1,725,000Total
                    operating expenses
                
                
                7,033,000
                
                
                6,708,000
                
                
                19,083,000
                
                
                20,995,000Loss
                    from operations
                
                
                (4,549,000
                )
                
                (3,325,000
                )
                
                (10,822,000
                )
                
                (11,026,000
                )Interest
                    and other income (expense)
                
                
                (84,000
                )
                
                23,000
                
                
                (181,000
                )
                
                146,000Loss
                    before provision for income taxes
                
                
                (4,633,000
                )
                
                (3,302,000
                )
                
                (11,003,000
                )
                
                (10,880,000
                )Provision
                    for income taxes
                
                
                —
                
                
                —
                
                
                —
                
                
                —Net
                    loss
                
                $
                (4,633,000
                )
                $
                (3,302,000
                )
                $
                (11,003,000
                )
                $
                (10,880,000
                )Basic
                    and diluted loss per share
                
                
                (
                    0.19
                )
                
                (
                    0.20
                )
                
                (
                    0.57
                )
                
                (
                    0.66
                )Weighted
                    average number of shares outstanding
                
                
                23,954,948
                
                
                16,504,206
                
                
                19,327,230
                
                
                16,396,029




See
      condensed notes to the consolidated financial statements.





-4-




**NORTH
      AMERICAN SCIENTIFIC, INC.**




**Consolidated
      Statements of Cash Flows**


**(Unaudited)**





**Nine
                Months Ended July 31,**Cash
                flows from operating activities:
            
            **2006**
            
            **2005**Net
                loss
            
            $
            (11,003,000
            )
            $
            (10,880,000
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            1,159,000
            
            
            2,546,000Amortization
                of warrants
            
            
            142,000
            
            
            —Share-based
                compensation expense
            
            
            730,000
            
            
            —Provision
                for doubtful accounts
            
            
            681,000
            
            
            623,000Provision
                for inventory reserve
            
            
            (340,000
            )
            
            418,000Changes
                in assets and liabilities, net of discontinued operation:Accounts
                receivable
            
            
            (530,000
            )
            
            383,000Inventories
            
            
            213,000
            
            
            648,000Prepaid
                and other current assets
            
            
            (270,000
            )
            
            (37,000
            )Accounts
                payable
            
            
            (467,000
            )
            
            (754,000
            )Accrued
                expenses
            
            
            (583,000
            )
            
            (730,000
            )Deferred
                revenue
            
            
            (716,000
            )
            
            (1,422,000
            )Net
                cash used in continuing operations
            
            
            (10,984,000
            )
            
            (9,205,000
            )Net
                cash used in discontinued operation
            
            
            (90,000
            )
            
            (548,000
            )Net
                cash used in operating activities
            
            
            (11,074,000
            )
            
            (9,753,000
            )Cash
                flows from investing activities:(Purchase
                of) Proceeds from maturity of marketable securities
            
            
            (8,956,000
            )
            
            8,999,000Capital
                expenditures
            
            
            (307,000
            )
            
            (246,000
            )Net
                cash provided by (used in) investing activities
            
            
            (9,263,000
            )
            
            8,753,000Cash
                flow from financing activities:Proceeds
                from exercise of stock options and stock purchase plan
            
            
            163,000
            
            
            718,000Proceeds
                from sale of common stock and warrants, net
            
            
            21,961,000
            
            
            —Net
                cash provided by finance activities
            
            
            22,124,000
            
            
            718,000Net
                (decrease) increase in cash and cash equivalents
            
            
            1,787,000
            
            
            (282,000
            )Cash
                and cash equivalents at beginning of period
            
            
            2,630,000
            
            
            2,334,000Cash
                and cash equivalents at end of period
            
            $
            4,417,000
            
            $
            2,052,000





Supplemental
      disclosure:




In
      the
      nine months ended July 31, 2006, the Company has issued warrants with an
      estimated fair value totaling $526,000 to a bank and a debt provider as
      consideration for entering into and amending Loan and Security Agreements.
      See
      Note 6 and Note 7 to the Financial Statements.





In
      the
      nine months ended July 31, 2006, there were no cash flows from investing
      activities or financing activities from discontinued operations.





See
      condensed notes to the consolidated financial statements.





-5-




**NORTH
        AMERICAN SCIENTIFIC, INC.**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 **(Unaudited)**
 
 **NOTE
        1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
 
 *Basis
        of Presentation*
 
 The
        accompanying consolidated financial statements of the Company are unaudited,
        other than the consolidated balance sheet at October 31, 2005, and reflect
        all
        material adjustments, consisting only of normal recurring adjustments, which
        management considers 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 current interim periods are not necessarily
        indicative of the results to be expected for the entire fiscal
        year.
 
 These
        consolidated financial statements have been prepared in accordance with the
        rules and regulations of the Securities and Exchange Commission (“SEC”). Certain
        information and footnotes normally included in financial statements prepared
        in
        accordance with generally accepted accounting principles in the United States
        of
        America have been condensed or omitted pursuant to these rules and regulations.
        These consolidated financial statements should be read in conjunction with
        the
        consolidated financial statements and the notes thereto included in the
        Company’s Form 10-K, as filed with the SEC for the fiscal year ended October 31,
        2005.
 
 Certain
        reclassifications have been made to prior period balances in order to conform
        to
        the current period presentation.
 
 *Management’s
        Plans*
 
 The
        accompanying financial statements have been prepared on a going concern basis,
        which contemplates the realization of assets and liquidation of liabilities
        in
        the normal course of business. However, the Company has continued to incur
        substantial net losses and used substantial amounts of cash. As of July 31,
        2006, the Company has an accumulated deficit of $121.4 million, cash, cash
        equivalents and investments in marketable securities of $14.4 million and
        no
        debt.
 
 Based
        on
        the Company’s current operating plans, management believes that the existing
        cash resources and cash forecasted by the Company’s plans to be generated by
        operations, as well as the Company’s anticipated and available lines of credit,
        will be sufficient to meet working capital and capital requirements through
        at
        least the next twelve months.  Also, management’s plans to attain
        profitability and generate additional cash flows include increasing revenues
        from existing and new products and services and a focus on cost control. 
However, there is no assurance that management will be successful with these
        plans.  If events and circumstances occur such that the Company does not
        meet our current operating plans as expected, and the Company is unable to
        raise
        additional debt or equity financing, the Company may be required to further
        reduce expenses or take other steps which could have a material adverse effect
        on the Company’s future performance, including but not limited to, the premature
        sale of some or all of the Company’s assets or product lines on undesirable
        terms, merger with or acquisition by another company on unsatisfactory terms,
        or
        the cessation of operations.
 
 -6-
  *Use
        of Estimates*
 
 In
        the
        normal course of preparing the financial statements in conformity with generally
        accepted accounting principles in the United States of America, management
        is
        required to make estimates and assumptions that affect the reported amounts
        of
        assets and liabilities and disclosure of contingent assets and liabilities
        at
        the date of the financial statements and reported amounts of revenue and
        expenses during the reporting period. Actual results could differ from those
        amounts.
 
 *Accounting
        for Stock-based Compensation*
 
 Effective
        November 1, 2005, the Company adopted Statement of Financial Accounting
        Standards (“SFAS”) No. 123(R), *Share-Based
        Payment* (“SFAS
        123(R)”), which requires the measurement and recognition of compensation expense
        for all share-based payment awards made to employees and directors, including
        stock options and employee stock purchases related to the Company’s Employee
        Stock Purchase Plan (the “Employee Stock Purchase Plan”), based on their fair
        values. SFAS 123(R) supersedes Accounting Principles Board Opinion No. 25, *Accounting
        for Stock Issued to Employees* (“APB
        25”), which the Company previously followed in accounting for stock-based
        awards. In March 2005, the SEC issued *Staff
        Accounting Bulletin No. 107* (“SAB
        107”) to provide guidance on SFAS 123(R). The Company has applied SAB 107 in
        its
        adoption of SFAS 123(R).
 
 The
        Company adopted SFAS 123(R) using the modified prospective transition method
        as
        of and for the nine months ended July 31, 2006. In accordance with the modified
        prospective transition method, the Company’s financial statements for prior
        periods have not been restated to reflect, and do not include, the impact
        of
        SFAS 123(R). Share-based compensation expense recognized is based on the
        value
        of the portion of share-based payment awards that is ultimately expected
        to
        vest. Share-based compensation expense recognized in the Company’s Condensed
        Consolidated Statement of Operations during the nine months ended July 31,
        2006
        includes compensation expense for share-based payment awards granted prior
        to,
        but not yet vested as of, October 31, 2005 based on the grant date fair value
        estimated in accordance with the pro forma provisions of SFAS 123 and new
        stock
        option grants made during the nine months ended July 31, 2006. A total of
        1,303,000 stock option grants were awarded to employees on March 16, 2006
        and a
        total of 150,000 stock option grants were awarded to directors on May 3,
        2006
        and June 14, 2006.
 
 In
        conjunction with the adoption of SFAS 123(R), the Company elected to attribute
        the value of share-based compensation to expense using the straight-line
        method,
        which was previously used for its pro forma information required under SFAS
        123
        and SFAS 148. Share-based compensation expense related to stock options and
        employee stock purchases was $251,000 for the three months ended July 31,
        2006
        and $730,000 for the nine months ended July 31, 2006, and was recorded in
        the
        financial statements as a component of general and administrative expense.
        Note
        that for the nine months ended July 31, 2006, a total of 651,500 stock options
        were granted that contain certain performance requirements, therefore no
        share-based compensation expense has been calculated on these stock
        options.
 
 During
        the nine months ended July 31, 2005, there was no share-based compensation
        expense related to stock options and employee stock purchases recognized
        under
        the intrinsic value method in accordance with APB 25. Had compensation cost
        for the Company’s stock options been recognized based upon the estimated fair
        value on the grant date under the fair 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:
 
 -7-
  **Three
                  Months EndedJuly 31, 2005**
              
              **Nine
                  Months Ended**
                **July
                  31, 2005**Net
                  loss, as reported
              
              $
              (3,302,000
              )
              $
              (10,880,000
              )Less:
                  total stock-based compensation (1)
              
              
              (303,000
              )
              
              (1,135,000
              )Net
                  loss, as adjusted
              
              $
              (3,605,000
              )
              $
              (12,015,000
              )Basic
                  and diluted loss per share, as reported
              
              $
              (0.20
              )
              $
              (0.66
              )Basic
                  and diluted loss per share, as adjusted
              
              $
              (0.22
              )
              $
              (0.73
              )
 
 (1)
        As
        determined under the fair value method.
 
 The
        Company uses the Black-Scholes option-pricing model for estimating the fair
        value of options granted. The Black-Scholes option-pricing model was developed
        for use in estimating the fair value of traded options that have no vesting
        restrictions and are fully transferable. In addition, option valuation models
        require the input of highly subjective assumptions, including the expected
        stock
        price volatility. The Company uses projected volatility rates, which are
        based
        upon historical volatility rates, trended into future years. Because the
        Company’s employee stock options have characteristics significantly different
        from those of traded options, and because changes in the subjective input
        assumptions can materially affect the fair value estimate, in management’s
        opinion, the existing models do not necessarily provide a reliable single
        measure of the fair value of the Company’s options. For purposes of financial
        statement presentation and pro forma disclosures, the estimated fair values
        of
        the options are amortized over the options’ vesting periods.
 
 *Revenue
        Recognition*
 
 The
        Company sells products and services for radiation therapy treatment of cancer,
        including intensity modulated radiation therapy (“IMRT”), image guided radiation
        therapy (“IGRT”), as well as brachytherapy. Product revenue consists of
        brachytherapy seeds and accessories, non-therapeutic sources, and certain
        IMRT
        hardware devices, including our MiMIC® and CraneTM products. Software revenues
        consist of IMRT treatment planning software, including Corvus®, Peregrine® and
        Peacock®, and our IGRT products. Service revenue consists of warranty revenue
        and maintenance service agreements.
 
 Product
        revenue
 
 The
        Company applies the provisions of SEC Staff Accounting Bulletin (“SAB”) No. 104,
“Revenue Recognition” for the sale of non-software products. SAB 104 which
        supersedes SAB No. 101, “Revenue Recognition 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 and provides guidance for the disclosure of revenue
        recognition policies. In general, the Company recognizes revenue related
        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.
 
 Software
        revenue
 
 The
        Company’s software product revenue is generated from the sale of advanced
        medical equipment products. The software element of the Company’s products is
        deemed an essential element of the functionality of the product. Maintenance
        and
        support are provided with the initial product sale for a twelve month period.
        The maintenance and support is renewable annually or longer, at the customer’s
        discretion.
  -8-
  The
        Company recognizes software revenue in accordance with the provisions of
        Statement of Position 97-2 (“SOP 97-2”), “Software Revenue Recognition”, as
        amended by Statement of Position 98-9 (“SOP 98-9”), “Modification of SOP 97-2,
        Software Revenue Recognition, with respect to Certain Transactions”. Under the
        provisions of SOP 97-2, the Company recognizes software revenue upon delivery
        and acceptance, provided all significant obligations have been met, persuasive
        evidence of an arrangement exists, fees are fixed or determinable, collection
        is
        probable, and the Company is not involved in providing services that are
        essential to the functionality of the product.
 
 The
        Company’s software sales are generally multiple element arrangements, which
        could include the product, first year annual maintenance and support, and
        training and installation. Revenues from the multiple elements arrangements
        are
        allocated to each element based on the relative fair value of the elements.
        If
        the fair value of the element exists, the determination is based on vendor
        specific objective evidence. If such evidence of fair value for each element
        of
        the arrangement does not exist, all revenue from the arrangement is deferred
        until such time that evidence of fair value of each element 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 more of the undelivered
        elements, the residual method of accounting is applied. Under the 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 maintenance and support contracts and are
        recognized on a straight-line basis over the term of the contract. Payments
        for
        maintenance revenues are normally received in advance and are nonrefundable.
 
 *Recent
        Accounting Pronouncements*
 
 In
        June
        2006, the FASB issued Interpretation No. 48, *Accounting
        for Uncertainty in Income Taxes — An Interpretation of FASB Statement
        No. 109,* (FIN 48).  FIN 48 clarifies the accounting for uncertainty in
        income taxes recognized in an enterprise’s financial statements in accordance
        with FASB Statement No. 109, *Accounting
        for Income Taxes.* FIN 48 also prescribes a recognition threshold and measurement attribute
        for the financial statement recognition and measurement of a tax position
        taken
        or expected to be taken in a tax return that results in a tax benefit.
        Additionally, FIN 48 provides guidance on de-recognition, income statement
        classification of interest and penalties, accounting in interim periods,
        disclosure, and transition. This interpretation is effective for fiscal years
        beginning after December 15, 2006. The Company is currently evaluating the
        effect that the application of FIN 48 will have on its results of
        operations and financial condition.
 
 In
        February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
        Financial Instruments” (“SFAS 155”), which amends SFAS No. 133, “Accounting for
        Derivatives Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 140,
“Accounting for Transfers and Servicing of Financial Assets and Extinguishment
        of Liabilities” (“SFAS 140).  SFAS 155 amends SFAS 133 to narrow the scope
        exception for interest-only and principal-only strips on debt instruments
        to
        include only such strips representing rights to receive a specified portion
        of
        the contractual interest or principle cash flows.  SFAS 155 also amends
        SFAS 140 to allow qualifying special-purpose entities to hold a passive
        derivative financial instrument pertaining to beneficial interests that itself
        is a derivative instrument.  SFAS No. 155 is effective for all financial
        instruments acquired or issued after the beginning of an entity’s first fiscal
        year that begins after September 15, 2006. The
        Company does not believe that SFAS No. 155 will have a material impact on
        the
        Company’s financial position, results of operations or cash flows.
 
 -9-
 
 In
        March
        2006, the FASB issued SFAS No. 156, “ Accounting
        for Servicing of Financial Assets” (“SFAS NO. 156”), which provides an approach
        to simplify efforts to obtain hedge-like (offset) accounting. This Statement
        amends FASB Statement No. 140, “Accounting for Transfers and Servicing of
        Financial Assets and Extinguishments of Liabilities”, with respect to the
        accounting for separately recognized servicing assets and servicing liabilities.
        The Statement (1) requires an entity to recognize a servicing asset or servicing
        liability each time it undertakes an obligation to service a financial asset
        by
        entering into a servicing contract in certain situations; (2) requires that
        a
        separately recognized servicing asset or servicing liability be initially
        measured at fair value, if practicable; (3) permits an entity to choose either
        the amortization method or the fair value method for subsequent measurement
        for
        each class of separately recognized servicing assets or servicing liabilities;
        (4) permits at initial adoption a one-time reclassification of
        available-for-sale securities to trading securities by an entity with recognized
        servicing rights, provided the securities reclassified offset the entity’s
        exposure to changes in the fair value of the servicing assets or liabilities;
        and (5) requires separate presentation of servicing assets and servicing
        liabilities subsequently measured at fair value in the balance sheet and
        additional disclosures for all separately recognized servicing assets and
        servicing liabilities. SFAS No. 156 is effective for all separately recognized
        servicing assets and liabilities as of the beginning of an entity’s fiscal year
        that begins after September 15, 2006, with earlier adoption permitted in
        certain
        circumstances. The Statement also describes the manner in which it should
        be
        initially applied. The Company does not believe that SFAS No. 156 will have
        a
        material impact on its financial position, results of operations or cash
        flows.
  **NOTE
        2** - **VARIABLE
        INTEREST ENTITY**
  In
        October 2003, the Company entered into a Secured Loan Agreement with Prostate
        Centers of America (“PCA”).  Under the agreement, the Company was obligated
        to make periodic advances subject to PCA achieving certain milestones.  On
        January 20, 2006, the Company received notice from PCA that it had filed
        for
        protection under the bankruptcy laws. As of July 31, 2006, the Company’s
        advances to PCA under the secured note totaling $950,000 have been written
        off.
        The Company has no equity interest in PCA.
  TC2B,
        LLC, a distributor who has agreed to procure all of its brachytherapy seeds
        exclusively from the Company through October 2008, has a majority interest
        in
        PCA. As of July 31, 2006, total trade receivables due from TC2B of $1.1 million
        had been written off to the allowance for doubtful accounts and no sales
        to TC2B
        during the nine months ended July 31, 2006 had been recognized. Based on
        the
        terms of the lending and supply agreements with the above entities, the Company
        previously determined that PCA is a variable interest entity (“VIE”) and the
        Company is the primary beneficiary under FIN No. 46 because PCA does not
        have sufficient equity at risk for the entity to finance its activities.
 
 FIN
        46
        requires that an enterprise consolidate a VIE if that enterprise has a variable
        interest that will absorb a majority of the entity’s expected losses if they
        occur. Accordingly, the Company adopted FIN No. 46 in October 2003 and
        consolidated PCA as a VIE, regardless of the Company not having an equity
        interest in PCA and its creditors having no recourse against the Company.
        In the
        fiscal year ended October 31, 2005, the Company determined that PCA was no
        longer a VIE, because: (i) during the fiscal year ended October 31, 2005,
        other
        outside parties provided additional funding to PCA, which resulted in the
        Company no longer being the holder of the variable interest that would hold
        the
        majority of the entity’s losses, (ii) PCA’s other creditors have no recourse
        against the Company, (iii) the Company has no equity interest in PCA, and
        (iv)
        PCA had informed the Company that it likely will cease operations in 2006.
        As a
        result, the Company did not consolidate PCA as a VIE in its financial statements
        for the fiscal year ended October 31, 2005.
 
 No
        amounts related to PCA were included in the Company’s consolidated balance
        sheets at July 31, 2006, and October 31, 2005.
 
 
 -10-
 On
          August
          28, 2006, a hearing was held in California federal court on the Company’s
          Application for Default Judgment against Randy Tibbits, who has personally
          guaranteed the obligations of PCA and TC2B. The court awarded the Company
          a
          judgment of $2.4 million.
 **NOTE
        3 - MARKETABLE SECURITIES**
 
 The
        Company invests excess cash in marketable securities consisting primarily
        of
        commercial paper, corporate notes and bonds, U.S. Government securities and
        money market funds. Investments with remaining maturities of less than one
        year
        are considered to be short term and are classified as current
        assets.
 
 Debt
        securities that the Company has the positive intent and ability to hold to
        maturity are classified as “held-to-maturity” and reported at amortized cost.
        Debt securities not classified as held-to-maturity and marketable equity
        securities are classified as “available-for-sale,” are recorded at fair value
        with unrealized gains and losses included in earnings or stockholders’ equity,
        respectively. All other equity securities are accounted for using either
        the
        cost method or the equity method.
 
 The
        Company continually reviews its investments to determine whether a decline
        in
        fair value below the cost basis is other than temporary. 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 of the write-down is included in
        the
        Consolidated Statements of Operations.
 
 **NOTE
        4 - ACCOUNTS RECEIVABLE**
 
 Accounts
        receivable are recorded at the invoiced amount and do not bear interest.
        The
        allowance for doubtful accounts is the Company’s best estimate of the amount of
        probable credit losses in our existing accounts receivable. The Company
        determines the allowance based on historical write-off experience and customer
        economic data. We review our allowance for doubtful accounts monthly. Past
        due
        balances over 60 days and over a specified amount are reviewed individually
        for
        collectibility. Account balances are charged off against the allowance when
        the
        Company believes that it is probable the receivable will not be recovered. As
        of
        July 31, 2006, total trade receivables due from TC2B of $1.1 million had
        been
        written off to the allowance for doubtful accounts (see
        Note 2). The Company does not have any off-balance-sheet credit exposure
        related
        to our customers.
 
 Accounts
        receivable consist of the following:
 
 **July
                  31,**
              
              **October
                  31,****2006**
              
              **2005**Accounts
                  receivables
              
              $
              6,400,000
              
              $
              6,854,000Less:
                  allowance for doubtful accounts
              
              
              (1,030,000
              )
              
              (1,333,000
              )$
              5,370,000
              
              $
              5,521,000
 
 **NOTE
        5 - INVENTORIES**
 
 Inventories
        are valued at the lower of cost or market as determined under the first-in,
        first-out method. Costs include materials, labor and manufacturing overhead.
        Inventories are shown net of applicable reserves and allowances. Inventories
        consist of the following:
 
 **July
                  31,**
              
              **October
                  31,****2006**
              
              **2005**Raw
                  materials
              
              $
              1,869,000
              
              $
              1,468,000Work
                  in process
              
              
              67,000
              
              
              45,000Finished
                  goods
              
              
              1,922,000
              
              
              2,218,000$
              3,858,000
              
              $
              3,731,000
  -11-
  **NOTE
        6 - LINE OF CREDIT**
 
 On
        October 5, 2005, the Company entered into a Loan and Security Agreement (the
        “Loan Agreement”) **** with
        Silicon Valley Bank (the “Bank”), for a secured, revolving line of credit of up
        to $5,000,000. The line of credit has a term of one year and includes a letter
        of credit sub-facility. Borrowings under the line of credit are subject to
        a
        borrowing base formula. The Company will pay interest on the borrowings under
        the line of credit at the Bank’s prime rate, which was 8.25% on July 31, 2006,
        or, if certain financial tests are not satisfied, at the Bank’s prime rate plus
        1.5%. The line of credit is secured by all of the assets of the Company and
        is
        subject to customary financial and other covenants, including reporting
        requirements.
 
 On
        January 12, 2006, the Company, entered into a First Amendment to Loan and
        Security Agreement (the “Amendment”) with the Bank.  The Amendment revised
        certain terms of the Loan Agreement to provide an adjustment to the borrowing
        base formula and to permit liens in favor of a holder of subordinated debt
        that
        are subordinated to the liens of the Bank.  In addition, the Amendment
        decreased the minimum tangible net worth that must be maintained by the Company
        under the Asset Based Terms of the Loan Agreement from $5 million to $1.5
        million and granted the Bank a warrant to purchase 39,683 shares of the
        Company’s common stock at an exercise price of $1.89 per share.  The
        warrant will expire in five years unless previously exercised. The
        Company calculated the fair value of the warrant on the date of grant to
        be
        $51,000 using the Black-Scholes model incorporating the following
        assumptions:
 
 Stock
                  price
              
              $
              1.89Dividend
                  yield
              
              
              0
              %Expected
                  volatility
              
              
              63
              %Risk-free
                  interest rate
              
              
              4.9
              %Expected
                  life
              
              
              5
                  years
 
 The
        value
        of the warrant is being amortized over the term of the line of credit at
        $5,100
        per month, and is included in Interest and Other Expense on the Income
        Statement.
 
 **NOTE
        7 - LONG TERM DEBT**
 
 On
        March
        28, 2006, the Company entered into a Loan and Security Agreement (the “Loan
        Agreement”) **** with
        Partners for Growth, LLC (the “Debt Provider”), for a secured, revolving line of
        credit of up to $4,000,000, which will supplement an existing line of credit
        provided by Silicon Valley Bank. The line of credit has a term of eighteen
        months. Borrowings under the line of credit are subject to a borrowing base
        formula. The Company has paid interest on the borrowings under the line of
        credit at prime rate as quoted in the *Wall
        Street Journal,* which on
        July 31, 2006 was 8.25%. Amounts owing under the line of credit are secured
        by
        all of the assets of the Company and are subordinated to amounts owing under
        the
        line of credit with Silicon Valley Bank. The line of credit does not contain
        financial covenants, however the Company is subject to other customary
        covenants, including reporting requirements, and events of default. In
        connection with the Loan Agreement, the Company also granted the Debt Provider
        a
        warrant to purchase 395,000 shares of the Company’s common stock at an exercise
        price of $1.89 per share. As a result of the private placement of the Company’s
        common stock completed on June 7, 2006 (see Note 13), and pursuant to the
        anti-dilution terms of the warrant issued to the Debt Provider, the warrant
        was
        amended to increase the number of shares of the Company’s common stock that the
        Debt Provider can purchase from 395,000 shares to 555,039 shares, and the
        exercise price was decreased from $1.89 per share to $1.35 per share. The
        warrant will expire in five years unless previously exercised. The
        Company calculated the fair value of the warrant on the date of grant to
        be
        $475,000 using the Black-Scholes model incorporating the following
        assumptions:
  -12-
  Stock
                  price
              
              $
              2.05Dividend
                  yield
              
              
              0
              %Expected
                  volatility
              
              
              63
              %Risk-free
                  interest rate
              
              
              4.9
              %Expected
                  life
              
              
              5
                  years
 
 The
        issuance of the warrant has been accounted for as a loan origination fee.
        As
        such, the value of the warrant has been deferred and is being amortized over
        the
        life of the loan at $26,500 per month and is included in Interest and Other
        Expense on the Income Statement.
 
 **NOTE
        8 - NET LOSS PER SHARE**
 
 Basic
        earnings (loss) per share is computed by dividing the net income (loss) by
        the
        weighted average number of shares outstanding for the period. Diluted earnings
        (loss) per share is computed by dividing the net income (loss) by the sum
        of the
        weighted average number of common shares outstanding for the period plus
        the
        assumed exercise of all dilutive securities by applying the treasury stock
        method unless such assumed exercises are anti-dilutive. The following table
        sets
        forth the computation of basic and diluted earnings (loss) per
        share:
  **Three
                    months ended July 31,**
                
                **Nine
                    months ended July 31,****2006**
                
                **2005**
                
                **2006**
                
                **2005**Net
                    loss
                
                $
                (4,633,000
                )
                $
                (3,302,000
                )
                $
                (11,003,000
                )
                $
                (10,880,000
                )Weighted
                    average shares outstanding - basic
                
                
                23,954,948
                
                
                16,504,206
                
                
                19,327,230
                
                
                16,396,029Dilutive
                    effect of stock options and warrants
                
                
                —
                
                
                —
                
                
                —
                
                
                —Weighted
                    average shares outstanding -diluted
                
                
                23,954,498
                
                
                16,504,206
                
                
                19,327,230
                
                
                16,396,029Basic
                    loss per share
                
                $
                (0.19
                )
                $
                (0.20
                )
                $
                (0.57
                )
                $
                (0.66
                )Diluted
                    loss per share
                
                $
                (0.19
                )
                $
                (0.20
                )
                $
                (0.57
                )
                $
                (0.66
                )
  Stock
        options to purchase 3,594,588 and 2,764,355 common shares for the three months
        ended July 31, 2006, and 2005, respectively, and 2,919,278 and 2,987,488
        common
        shares for the nine months ended July 31, 2006 and 2005, respectively, were
        not
        included in the computation of diluted earnings per share because their effect
        would have been anti-dilutive.
 
 **NOTE
        9**-**INTANGIBLE
        ASSETS**
 **July
                    31, 2006**
                
                **October
                    31, 2005****Gross
                    Carrying Amount**
                
                **Accumulated
                    Amortization**
                
                **Gross
                    Carrying Amount**
                
                **Accumulated
                    Amortization**Amortizable
                    intangible assetsPurchased
                    technology
                
                $
                3,129,000
                
                $
                2,698,000
                
                $
                3,129,000
                
                $
                2,622,000Existing
                    customer relationships
                
                
                1,770,000
                
                
                566,000
                
                
                1,770,000
                
                
                353,000Trademark
                
                
                1,666,000
                
                
                666,000
                
                
                1,666,000
                
                
                490,000Patents
                    and licenses
                
                
                98,000
                
                
                45,000
                
                
                98,000
                
                
                40,000$
                6,663,000
                
                $
                3,975,000
                
                $
                6,663,000
                
                $
                3,505,000
  -13-
  Amortization
        expense was $157,000 and $575,000 for the three months ended July 31, 2006
        and
        2005, respectively, and $471,000 and $1,725,000 for the nine months ended
        July
        31, 2006 and 2005, respectively.
 
 The
        Company’s current estimate of aggregate amortization expense for subsequent
        years is as follows:
 
 **For
                  the Years Ended July 31,**2007
              
              $
              626,0002008
              
              
              626,0002009
              
              
              626,0002010
              
              
              626,0002011
              
              
              184,000$
              2,688,000
 
 **NOTE
        10 - DISCONTINUED OPERATION**
 
 In
        September 2004, the Company shut-down its Theseus operation. Effective with
        the
        fourth quarter of 2004, this segment is reflected as a discontinued operation.
        All prior period results have been restated accordingly, including the
        reallocation of fixed overhead charges to other business segments.
 
 There
        were no revenues or expenses from the discontinued operation in the nine
        months
        ended July 31, 2006 and 2005.
 
 Assets
        and liabilities of the discontinued operations were as follows:
  **July
                  31,**
              
              **October
                  31,****2006**
              
              **2005**Other
                  assets
              
              
              16,000
              
              
              16,000Accounts
                  payable
              
              
              —
              
              
              (3,000
              )Accrued
                  expenses
              
              
              (263,000
              )
              
              (350,000
              )Net
                  liabilities of discontinued operation
              
              $
              (247,000
              )
              $
              (337,000
              )
 
 When
        reporting the restated prior period results showing the Theseus operation
        as a
        discontinued operation, the Company combined the cash flows attributable
        to
        Theseus within the operating cash flow category. The following table reports,
        for the last 3 fiscal years, separate totals of operating, investing and
        financing portions of the cash flows attributable to the discontinued
        operation:
  **For
                  the Years Ended October 31,****2005**
              
              **2004**
              
              **2003**Net
                  cash used in discontinued operating activities
              
              $
              578,000
              
              $
              8,214,000
              
              $
              8,320,000Net
                  cash used in discontinued investing activities
              
              
              —
              
              
              179,000
              
              
              310,000Net
                  cash used in discontinued financing activities
              
              
              —
              
              
              —
              
              
              —Total
                  cash used in discontinued operations
              
              $
              578,000
              
              $
              8,393,000
              
              $
              8,630,000
  -14-
  **NOTE
        11 - SEGMENT INFORMATION**
 
 The
        Company’s operations are divided into segments based upon a combination of
        factors including: product produced, manufacturing process and management
        oversight.  The Company’s two segments are: IMRT/IGRT and Radiation
        Sources. IMRT/IGRT develops and markets products used during external beam
        radiation therapy for the treatment of cancer.  Radiation Sources develops
        and markets radioisotopic products including brachytherapy seeds and accessories
        used in the treatment of cancer and non-therapeutic products used in medical,
        environmental, research and industrial applications.
 
 The
        Company evaluates performance and allocates resources based upon operating
        results and development milestones. The accounting polices of the reportable
        segments are the same as those described in Note 1 in the summary of significant
        accounting policies. There are no inter-company sales or profits.
 
 The
        Company’s segments are business units that either offer different products or
        are managed separately because they operate with distinct manufacturing and
        development processes.
 
 **Three
                  months ended July 31,**
              
              **Nine
                  months ended July 31,****2006**
              
              **2005**
              
              **2006**
              
              **2005****Revenues**IMRT/IGRT
              
              $
              3,931,000
              
              $
              5,005,000
              
              $
              13,437,000
              
              $
              16,415,000Radiation
                  Sources
              
              
              3,166,000
              
              
              3,055,000
              
              
              9,244,000
              
              
              8,951,000$
              7,097,000
              
              $
              8,060,000
              
              $
              22,681,000
              
              $
              25,366,000**Loss
                  from Operations**IMRT/IGRT
              
              $
              (2,546,000
              )
              $
              (2,572,000
              )
              $
              (5,904,000
              )
              $
              (8,053,000
              )Radiation
                  Sources
              
              
              (2,003,000
              )
              
              (753,000
              )
              
              (4,918,000
              )
              
              (2,973,000
              )$
              (4,549,000
              )
              $
              (3,325,000
              )
              $
              (10,822,000
              )
              $
              (11,026,000
              )
 
 **July
                  31,**
              
              **October
                  31,****2006**
              
              **2005****Goodwill**IMRT/IGRT
              
              $
              2,564,000
              
              $
              2,564,000$
              2,564,000
              
              $
              2,564,000**Total
                  assets**IMRT/IGRT
              
              $
              18,592,000
              
              $
              14,899,000Radiation
                  Sources
              
              
              14,250,000
              
              
              7,418,000Discontinued
                  operation
              
              
              16,000
              
              
              16,000$
              32,858,000
              
              $
              22,333,000
  -15-


**NOTE
      12—COMMITMENTS AND CONTINGENCIES**





*Contract
      Commitments*





The
      Company has entered into purchase commitments of $0.1 million to suppliers
      under
      blanket purchase orders.





*Lease
      Commitments*





The
      Company leases facilities and equipment under non-cancelable operating lease
      agreements. Future minimum lease payments are subject to annual adjustment
      for
      increases in the Consumer Price Index. Future minimum annual lease payments
      under all operating leases are as follows:





**For
                the Years Ended July 31,**2007
            
            $
            639,0002008
            
            
            492,0002009
            
            
            492,0002010
            
            
            492,0002011
            
            
            492,000Thereafter
            
            
            779,000$
            3,386,000





*Third
      Party License Agreements*




We
      license from third parties some of the technologies used in our core products.
      The following are the minimum annual royalty amounts under each of the
      agreements:




Lawrence
                Livermore National Laboratory
            
            $
            25,000Wisconsin
                Alumni Research Foundation
            
            
            15,000University
                of Texas
            
            
            50,000National
                Research Council of Canada
            
            
            30,000$
            120,000




*Employment
      Agreements*





The
      Company maintains employment agreements with certain key management. The
      agreements provide for minimum base salaries, eligibility for stock options
      and
      performance bonuses and severance payments.





*Litigation*





In
      December 2004, an individual plaintiff, Steven Weeks, filed a complaint in
      the
      Coos County Circuit Court of the State of Oregon against Bay Area Health
      District, North American Scientific, Inc., NOMOS Corporation and Carl Jenson,
      M.D., alleging the defendants caused Mr. Weeks to receive excessive radiation
      during the course of his IMRT treatment, as a result of a manufacturing and/or
      design defect(s) in the Company’s CORVUS and BAT products. In September 2005,
      prior to the case going to trial, the Company was party to a settlement
      agreement and the lawsuit is no longer an ongoing matter. Under the arrangement,
      the parties mutually agreed to dismiss all claims and counterclaims against
      each
      other without admitting any wrongdoing. The Company has also settled
      pre-litigation claims asserted against the same set of defendants by three
      separate plaintiffs, and believes that no other claims are forthcoming. These
      pre-litigation claims were subject to a settlement agreement whereby the parties
      agreed not to bring any claims or counterclaims against each other without
      admitting any wrongdoing.




-16-




In
      November 2005, the Company was served with a complaint filed in U.S. District
      Court in Hartford, Connecticut by World Wide Medical Technologies (WWMT). WWMT’s
      six count complaint alleges breach of a confidentiality agreement, fraud, patent
      infringement, wrongful interference with contractual relations, violation of
      the
      Connecticut Uniform Trade Secrets Act, and violation of the Connecticut Unfair
      Practices Act. WWMT alleges that the Company fraudulently obtained WWMT’s
      confidential information during negotiations to purchase WWMT in 2004 and that
      once the Company acquired that information, it purportedly learned that Richard
      Terwilliger (our current Vice President of New Product Development) owned
      certain patent rights and that we began trying to inappropriately gain property
      rights by hiring him away from WWMT. The Company was served with this matter
      at
      approximately the same time Mr. Terwilliger was served with a lawsuit in
      state court and with an application seeking a preliminary
      injunction declaring plaintiffs to be the sole owners of the intellectual
      property at issue and preventing Mr. Terwilliger from effectively serving
      as Vice President of New Product Development at the Company. The Company has
      agreed to defend Mr. Terwilliger. We have removed the state court claim against
      Mr. Terwilliger to federal court and the cases have been
      consolidated.   The defendants have answered both complaints
      and discovery has commenced in each matter. In April 2006, WWMT had its hearing
      for a preliminary injunction against Mr. Terwilliger heard in U.S. District
      Court.   Plaintiffs abandoned that portion of their application for
      preliminary injunction that was based on an alleged misappropriation of trade
      secrets shortly before the hearing.     On August 30, 2006,
      Magistrate Judge Donna Martinez issued a ruling recommending that what
      remained of plaintiffs' motion be denied.  Specifically, the
      Magistrate Judge found that plaintiffs do not have a reasonable likelihood
      of
      success on the merits of their claim for declaratory judgment that some or
      all
      of plaintiffs are the sole owners of the intellectual property at issues, and
      she further found that there do not exist sufficiently serious questions
      going to the merits of that claim to make them a fair ground for
      litigation.  The Company does not yet know whether plaintiffs will object
      to the Magistrate Judge's recommended ruling.   The Company denies
      liability and intends to vigorously defend itself in this
      litigation as it progresses.





On
      April
      20, 2006, a lawsuit captioned *J.P.
      Morgan Trust Company, N.A. v. John Alan Friede, et al.* was
      filed in the U.S. District Court for the Southern District of New York against
      John A. Friede, a current director and stockholder of the Company, Mr. Friede’s
      wife, and NOMOS Corporation, a subsidiary of the Company. The plaintiff, J.P.
      Morgan Trust Company, filed the lawsuit in its capacity as personal
      representative of the Estate of Evelyn A.J. Hall, Mr. Friede’s deceased mother.
      The complaint, as amended on August 8, 2006, asserts claims for reimbursement
      and contribution, constructive fraud, breach of contract and other related
      claims arising out of loans made by Mrs. Hall to, or for the benefit of, Mr.
      and
      Mrs. Friede and/or NOMOS, or acting as an accommodation party in additional
      loans made to Mr. and Mrs. Friede by financial institutions that were not
      subsequently repaid. During the time periods alleged in the complaint, Mr.
      Friede was the Chairman, Chief Executive Officer and the largest stockholder
      of
      NOMOS. With respect to NOMOS, the complaint seeks at least approximately
      $5,250,000 principal amount of loans allegedly made to and still outstanding
      and
      owed by NOMOS, and other related equitable remedies plus interest, costs and
      expenses.





On
      the
      basis of copies of documents that have been made available to us, we believe
      that the claims made against NOMOS in the lawsuit appear to be without merit
      and
      we intend to vigorously defend against them. However, in accordance with the
      indemnification provisions of the merger agreement under which we acquired
      NOMOS
      on May 4, 2004, and the related indemnity escrow agreement, we have made a
      claim
      for indemnification against the escrow to preserve our right of indemnity.
      Under
      these provisions, an indemnifying party will not have any indemnification
      obligations until such time as the aggregate indemnified losses for which we
      are
      entitled to indemnification equals or exceeds $400,000, at which point, the
      indemnifying party will be liable for the full amount of all such indemnified
      losses without regard to the $400,000 basket. As of the date hereof, the
      indemnity escrow account holds approximately $1,225,000 of cash and 526,810
      shares of our common stock. We also intend to review various other legal
      remedies that may be available to us.




-17-




The
      Company is also subject to other legal proceedings, claims and litigation.
      While
      the outcome of these matters is currently not determinable, management does
      not
      expect that the ultimate costs to resolve these matters will have a material
      adverse effect on the Company's consolidated financial position, results of
      operations, or cash flows.





**NOTE
      13—STOCKHOLDERS' EQUITY**





*Sale
      of Common Stock and Warrants*





On
      June
      7, 2006, we completed a private placement of 12,291,934
      shares of the Company’s common stock at a purchase price of $1.95 per share as
      well as warrants to purchase an additional 6,145,967 shares of the Company’s
      common stock at an exercise price of $2.08 per share for an aggregate
      consideration of approximately $24.0 million (before cash commissions and
      expenses of approximately $2.0 million). The warrants are exercisable beginning
      180 days after the date of closing until 7 years after the date of closing.
      The
      values of the warrants and common stock in excess of par value have been
      classified as stockholders’ equity in additional paid-in capital in our
      consolidated balance sheet as of July 31, 2006. The warrants were evaluated
      under SFAS 133 and EITF 00-19, and the Company determined that the warrants
      have
      been correctly classified as equity.




The
      shares of common stock sold to the investors and the shares of common stock
      issuable upon the exercise of the warrants are subject to certain registration
      rights as set forth in the Securities Purchase Agreements. Under the Securities
      Purchase Agreements, we agreed to file a registration statement with the
      Securities and Exchange Commission within 45 days after the closing of the
      transaction to register the resale of the shares of common stock and the shares
      of common stock issuable upon the exercise of the warrants. If we failed to
      file
      a registration statement within such time period or such registration statement
      was not declared effective within 90 days after the closing of the transaction,
      we would have been liable for certain specified liquidated damages as set forth
      in the Securities Purchase Agreements, except that the parties have agreed
      that
      the Company will not be liable for liquidated damages with respect to the
      warrants or the warrant shares. We have agreed to maintain the effectiveness
      of
      this registration statement until the earlier of such time as the passage of
      two
      years from the closing date or all of the securities registered under the
      registration statement may be sold under Rule 144(k) of the Securities Act
      of
      1933 or all of the securities registered under the registration statement have
      been sold. We will pay all expenses incurred in connection with the
      registration, except for underwriting discounts and commissions. Pursuant to
      the
      terms of the Securities Purchase Agreement, we filed a registration statement
      on
      Form S-3 with the Securities and Exchange Commission on July 21, 2006 to
      register the shares of common stock sold to the investors and the shares of
      common stock issuable upon the exercise of the warrants. The registration
      statement was declared effective by the Securities and Exchange Commission
      on
      August 4, 2006.





The
      Securities Purchase Agreements contain certain customary closing conditions,
      as
      well as the requirement that we increase the number of members of the Board
      of
      Directors of the Company (the “Board”) from seven members to nine members. Under
      the Securities Purchase Agreements, Three Arch Partners, one of the investors,
      has the right to designate two members to the Board so long as Three Arch
      Partners beneficially owns greater than 3,500,000 shares of common stock
      (including shares of common stock issuable upon exercise of the warrants, and
      as
      appropriately adjusted for stock splits, stock dividends and recapitalizations)
      and the right to designate one member to the Board so long as Three Arch
      Partners beneficially owns greater than 2,000,000 shares of common stock
      (including shares of common stock issuable upon exercise of the warrants, and
      as
      appropriately adjusted for stock splits, stock dividends and recapitalizations).
      In accordance with the terms of the Securities Purchase Agreements, we increased
      the number of members of our Board from seven members to nine members and Three
      Arch Partners designated Wilfred E. Jaeger, M.D. and Roderick A. Young to fill
      the two vacancies. Our Board elected Dr. Jaeger and Mr. Young to serve as
      members of the Board on June 13, 2006.




-18-




In
      connection with the issuance of the warrants and upon closing of the
      transaction, we entered into a Warrant Agreement with our transfer agent
      relating to the warrant of Three Arch Partners and a different Warrant Agreement
      with our transfer agent relating to the warrants of the investors other than
      Three Arch Partners. The material differences between the two Warrant Agreements
      are described below.





The
      Three
      Arch Partners Warrant Agreement includes a non-waivable provision that provides
      that the number of shares issuable upon exercise of the warrants that may be
      acquired by Three Arch Partners will be limited to the extent necessary to
      assure that, following such exercise, the total number of shares of common
      stock
      then beneficially owned by Three Arch Partners and its affiliates does not
      exceed 19.9% of the total number of issued and outstanding shares of common
      stock as of the date of such exercise (including for such purpose the shares
      of
      common stock issuable upon such exercise of warrants), unless approved by our
      stockholders prior to such exercise. The Warrant Agreement relating to the
      warrants of the other investors does not include such a provision.





The
      Warrant Agreement relating to the investors other than Three Arch Partners
      includes a waivable provision that provides that the number of shares issuable
      upon exercise of the warrants that may be acquired by a registered holder of
      warrants upon an exercise of warrants will be limited to the extent necessary
      to
      assure that, following such exercise, the total number of shares of common
      stock
      then beneficially owned by its holder and its affiliates does not exceed 4.99%
      of the total number of issued and outstanding shares of common stock (including
      for such purpose the shares of common stock issuable upon such exercise of
      warrants). This provision may be waived by a registered holder of warrants
      upon,
      at the election of such holder, upon not less than 61 days prior notice to
      us.
      This Warrant Agreement also contains a non-waivable provision that provides
      that
      the number of shares issuable upon exercise of the warrants that may be acquired
      by a registered holder of warrants upon an exercise of warrants will be limited
      to the extent necessary to assure that, following such exercise, the total
      number of shares of common stock then beneficially owned by such holder and
      its
      affiliates does not exceed 9.99% of the total number of issued and outstanding
      shares of common stock (including for such purpose the shares of common stock
      issuable upon such exercise of warrants). The Warrant Agreement relating to
      the
      warrants of Three Arch Partners does not include such provisions.





*Stock
      Options*





The
      Company's 1996 Stock Option Plan ("1996 Plan"), as amended April 6, 2001,
      provided for the issuance of incentive stock options to employees of the Company
      and non-qualified options to employees, directors and consultants of the Company
      with exercise prices equal to the fair market value of the Company's stock
      on
      the date of grant. Certain options are immediately exercisable while other
      options vest over periods up to four years. The options expire ten years from
      the date of grant. The 1996 Plan provided for the automatic increase on
      January 1 of each year, beginning with calendar year 2002 and continuing
      through calendar year 2004, by a number of shares equal to 3.5% of the total
      number of shares of the Company's Common Stock outstanding on the last trading
      day in the immediately preceding calendar year. In May 2004, the Company’s
      shareholders approved proposals to amend the 1996 Plan to make an additional
      600,000 shares available for issuance under the plan and to permit the issuance
      of 1,362,589 replacement options in connection with the acquisition of NOMOS.
      The 1996 Plan expired on April 1, 2006.




-19-




On
      May 3,
      2006, the Company’s shareholders approved the North American Scientific, Inc.
      2006 Stock Plan (“2006 Plan”). Under the 2006 Plan, the Company may issue up to
      1,700,000 shares, plus any shares from the 1996 Plan that are subsequently
      terminated, expire unexercised or forfeited, to employees of the Company through
      incentive stock options, non-qualified options, stock appreciation rights,
      restricted stock and restricted stock units. The exercise price of an option
      is
      equal to the fair market value of the Company’s stock on the date of the grant.
      At July 31, 2006, no equity awards have been granted under the 2006
      Plan.





In
      March 2003, the Company's shareholders approved the 2003 Non-Employee
      Directors' Equity Compensation Plan ("Directors' Plan"). The Directors' Plan
      supersedes prior provisions for grants of stock options to non-employee
      directors contained in the 1996 Plan. Under the Directors' Plan, the Company
      may
      issue up to 500,000 shares to non-employee directors of the Company through
      non-qualified options or restricted stock. The exercise price of an option
      is
      equal to the fair market value of the Company's stock on the date of grant.
      Options and restricted stock vest equally over a three-year period. The options
      expire ten years from the date of grant. At July 31, 2006, there were 85,000
      shares available for grant under the Directors’ Plan.





At
      July
      31, 2006, a total of 5,328,800 shares of the Company’s common stock were
      reserved for issuance.





The
      following table summarizes stock option activity for both plans:





**Options
                Outstanding****Options**
              **Available**
              **for
                Grant**
            
            **Number**
              **Outstanding**
            
            **Exercise
                Price**Balance
                at October 31, 2003
            
            
            549,188
            
            
            2,678,954
            
            
            $0.03
                  - $24.54Granted
            
            
            (306,000
            )
            
            306,000
            
            
            $7.49
                  - $10.01Replacement
                options
            
            
            (1,362,589
            )
            
            1,362,589
            
            
            $1.10
                  - $4.42Canceled
                or expired
            
            
            375,858
            
            
            (375,858
            )
            
            $1.11
                    - $22.11Exercised
            
            
            —
            
            
            (717,864
            )
            
            $1.11
                  - $7.94Additional
                shares reserved
            
            
            2,323,285
            
            
            —Balance
                at October 31, 2004
            
            
            1,579,742
            
            
            3,253,821
            
            
            $0.03
                  - $24.54Granted
            
            
            (275,000
            )
            
            275,000
            
            
            $2.25
                  - $3.66Canceled
                or expired
            
            
            427,699
            
            
            (427,699
            )
            
            $1.11
                  - $16.75Exercised
            
            
            —
            
            
            (687,013
            )
            
            $1.11
                  - $1.96Balance
                at October 31, 2005
            
            
            1,732,441
            
            
            2,414,109
            
            
            $0.03
                  - $24.54Granted
            
            
            (1,453,000
            )
            
            1,453,000
            
            
            $1.92
                    - $3.35Canceled
                or expired
            
            
            (194,441
            )
            
            (322,918
            )
            
            $1.11
                  - $16.75Exercised
            
            
            —
            
            
            (391
            )
            
            $1.12Additional
                shares reserved
            
            
            1,700,000
            
            
            —Balance
                at July 31, 2006
            
            
            1,785,000
            
            
            3,543,800
            
            
            $0.70
                  - $24.54




There
      were 1,750,375, 1,873,220 and 1,591,598 options exercisable with weighted
      average exercise prices of $8.83, $8.79 and $9.31 at July 31, 2006,
      October 31, 2005 and 2004, respectively.





-20-




The
      following table summarizes options outstanding at July 31, 2006 and the related
      weighted average exercise price and remaining contractual life
      information:





**Employee
                Options Outstanding**
            
            **Employee
                Options Exercisable****Range
                of****Exercise
                Prices**
            
            **Shares**
            
            **Weighted
                Avg.**
              **Remaining**
              **Contractual**
              **Life
                (Years)**
            
            **Weighted**
              **Avg.**
              **Exercise**
              **Price**
            
            **Shares**
            
            **Weighted**
              **Avg.**
              **Exercise**
              **Price**$
                0.70 - $2.23
            
            
            1,054,495
            
            
            5.97
            
            $
            1.83
            
            
            268,850
            
            $
            0.85$3.18
                - $3.35
            
            
            861,500
            
            
            8.00
            
            
            3.30
            
            
            —
            
            
            —$3.94
                - $7.94
            
            
            800,395
            
            
            5.25
            
            
            7.12
            
            
            711,114
            
            
            7.10$8.30
                - $16.75
            
            
            720,450
            
            
            5.52
            
            
            11.31
            
            
            663,451
            
            
            11.51$22.11
                - $24.54
            
            
            106,960
            
            
            2.16
            
            
            23.68
            
            
            106,960
            
            
            23.683,543,800
            
            
            6.09
            
            $
            6.08
            
            
            1,750,375
            
            $
            8.83





The
      average fair value for accounting purposes of options granted was $1.09, $2.47
      and $5.19 for the nine months ended July 31, 2006 and the years ended
      October 31, 2005 and 2004, respectively.





The
      following table summarizes the weighted average price, weighted average
      remaining contractual life and intrinsic value for granted and exercisable
      options outstanding as of July 31, 2006 and October 31, 2005:





**Number
                of Shares**
            
            **Weighted
                Average Exercise Price**
            
            **Weighted
                Avg.**
              **Remaining**
              **Contractual**
              **Life
                (Years)**
            
            **Intrinsic
                Value***As
                of October 31, 2005:*Employee
                Options Outstanding
            
            
            2,414,109
            
            $
            8.13
            
            
            6.09
            
            $
            464,000Employee
                Options Expected to Vest
            
            
            540,889
            
            $
            5.67
            
            
            8.91
            
            $
            4,000Employee
                Options Exercisable
            
            
            1,873,220
            
            $
            8.79
            
            
            5.25
            
            $
            460,000*As
                of July 31, 2006*Employee
                Options Outstanding
            
            
            3,543,800
            
            $
            6.08
            
            
            6.09
            
            $
            263,000Employee
                Options Expected to Vest
            
            
            1,736,274
            
            $
            2.68
            
            
            7.11
            
            $
            —Employee
                Options Exercisable
            
            
            1,750,375
            
            $
            8.83
            
            
            4.53
            
            $
            263,000




-21-




*Fair
      Value Disclosures*





The
      Company calculated the fair value of each option grant on the respective date
      of
      grant using the Black-Scholes option-pricing model as prescribed by
      SFAS 123 using the following assumptions:





**Nine
                Months EndedJuly 31**
            
            **Year
                Ended October 31,****2006**
            
            **2005**
            
            **2004**Dividend
                yield
            
            
            0
            %
            
            0
            %
            
            0
            %Expected
                volatility
            
            
            63
            %
            
            82
            %
            
            74
            %Risk-free
                interest rate
            
            
            4.9
            %
            
            3.9
            %
            
            3.3
            %Expected
                life
            
            
            5
                years
            
            
            5
                years
            
            
            5
                years





*Employee
      Stock Purchase Plan*





The
      Company has an Employee Stock Purchase Plan ("the ESPP") under which 300,000
      shares of the Company's common stock are reserved for issuance. Eligible
      employees may authorize payroll deductions of up to 15% of their salary to
      purchase shares of the Company's common stock at a discount of up to 15% of
      the
      market value at certain plan-defined dates. In the nine months ended July 31,
      2006 and the years ended October 31, 2005 and 2004, the shares issued under
      the
      ESPP were 96,489, 59,742 and 24,285 shares, respectively. At July 31, 2006,
      73,839 shares were available for issuance under the ESPP.





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





The
      following discussion and analysis provides information, which our management
      believes is relevant to an assessment and understanding of our financial
      condition and results of operations. The discussion should be read in
      conjunction with the Consolidated Financial Statements contained herein and
      the
      notes thereto. Certain statements contained in this Quarterly Report on
      Form 10-Q, including, without limitation, statements containing the words
“believes”, “anticipates”, “estimates”, “expects”, “projections”, and words of
      similar import are forward looking as that term is defined by: (i) the
      Private 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
      and
      with the intention of obtaining the benefits of the "Safe Harbor" provisions
      of
      the 1995 Act. We caution that any forward looking statements made herein are
      not
      guarantees of future performance and that actual results may differ materially
      from those in such forward looking statements as a result of various factors,
      including, but not limited to, any risks detailed herein or detailed from time
      to time in our other filings with the SEC including our most recent annual
      report on Form 10-K, as amended. We are not undertaking any obligation to
      update publicly any forward-looking statements. Readers should not place undue
      reliance on these forward-looking statements.





**Overview**





We
      manufacture, market and sell products for the radiation oncology community,
      including intensity modulated and image guided radiation therapy products and
      services, as well as brachytherapy seeds used in the treatment of prostate
      cancer. Our business is organized into two operating segments: IMRT/IGRT and
      Radiation Sources.





IMRT/IGRT
      develops and markets intensity modulated radiation therapy (“IMRT”) and image
      guided radiation therapy (“IGRT”) products used in external beam radiation
      therapy for the treatment of diseases. Radiation Sources develops and markets
      radioisotopic products including brachytherapy seeds, accessories and
      calibration sources used in the treatment of diseases and used 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 and IGRT products and services. We manage this business
      as
      our IMRT/IGRT operating segment.





-22-




Based
      on
      our current operating plans, we believe that the existing cash resources and
      cash forecasted by our plans to be generated by operations, as well as our
      anticipated and available lines of credit, will be sufficient to meet working
      capital and capital requirements through at least the next twelve months.
 Also, our plans to attain profitability and generate additional cash flows
      include increasing revenues from existing and new products and services and
      a
      focus on cost control.  However, there is no assurance that we will be
      successful with these plans.  If events and circumstances occur such that
      we do not meet our current operating plans as expected, and we are unable to
      raise additional debt or equity financing, we may be required to further reduce
      expenses or take other steps which could have a material adverse effect on
      our
      future performance, including but not limited to, the premature sale of some
      or
      all of the Company’s assets or product lines on undesirable terms, merger with
      or acquisition by another company on unsatisfactory terms, or the cessation
      of
      operations.





**Results
      of Operations**





**Three
      Months Ended July 31, 2006 Compared to Three Months Ended July 31,
      2005**





**Revenue** .
      Revenue
      decreased $1.0 million, or 12%, to $7.1 million for the three months ended
      July
      31, 2006, from $8.1 million for the three months ended July 31, 2005. The
      decrease in revenue during the quarter ended July 31, 2006 is primarily
      attributable to a decline in the volume of IMRT/IGRT products sold ($0.6
      million) and a decline in the number of maintenance and warranty agreements
      for
      IMRT/IGRT products ($0.5 million) partially offset by an increase in Radiation
      Sources revenue ($0.1 million).





Product
      revenue decreased $0.5 million, or 10%, to $4.6 million for the three months
      ended July 31, 2006, from $5.1 million for the three months ended July 31,
      2005.
      Radiation Sources product revenue increased $0.1 million for the three months
      ended July 31, 2006 primarily due to a product mix shift toward the higher
      priced palladium seeds. This was offset by a decline in unit volume for
      IMRT/IGRT products.





Service
      revenue decreased $0.5 million, or 15%, to $2.5 million for the three months
      ended July 31, 2006, from $3.0 million for the three months ended July 31,
      2005
      due to a decline in the number of maintenance agreements for IMRT/IGRT products.





**Gross
      profit** .
      Gross
      profit decreased $0.9 million, or 27%, to $2.5 million for the three months
      ended July 31, 2006, from $3.4 million for the three months ended July 31,
      2005.
      The decrease in gross profit is attributed to declining product and service
      revenues partially offset by lower material costs in our IMRT/IGRT business
      ($0.7 million) and a product mix shift toward lower margin palladium seeds
      and
      start-up costs of our in-house stranding operations in our Radiation Sources
      business ($0.2 million). Gross profit as a percentage of revenues decreased
      from
      42% to 35% during this period.





Gross
      profit for the three months ended July 31, 2006 consisted of $1.5 million,
      or
      38% of revenue from our IMRT/IGRT business and $1.0 million, or 31%, of revenue
      from our Radiation Sources business. We expect gross margins in our Radiation
      Sources business to improve as we increase the number of brachytherapy seeds
      stranded in-house.





**Selling
      expenses** .
      Selling
      expenses include salaries, commissions and other related costs associated with
      our sales and marketing personnel and advertising, trade shows and other
      promotional programs. Selling expenses decreased $0.1 million, or 5%, to $2.0
      million for the three months ended July 31, 2006, from $2.1 million for the
      three months ended July 31, 2005. The decrease in selling expenses is primarily
      attributed to a decline in personnel costs due to a restructuring of the sales
      force and a reduction in commission due to lower sales.





**General
      and administrative expenses** .
      General
      and administrative (“G&A”) expenses include salaries and other related costs
      associated with finance, executive, human resources and information technology
      personnel and other administrative costs. G&A expenses increased $1.1
      million, or 44%, to $3.5 million for the three months ended July 31, 2006,
      from
      $2.4 million for the three months ended July 31, 2005. The increase is primarily
      attributed to a $0.9 million increase in litigation-related legal fees, $0.1
      million for settlement of lawsuits and $0.3 million in stock compensation
      expense as a result of the implementation of SFAS 123R which requires the
      expensing of stock options, partially offset by reductions in personnel
      costs.





-23-




**Research
      and development expenses** .
      Research and development (“R&D”) expenses include salaries and other related
      costs associated with product development, third party development costs,
      overhead costs and material used in development of prototypes. Our R&D costs
      decreased $0.2 million, or 15%, to $1.3 million for the three months ended
      July
      31, 2006, from $1.5 million for the three months ended July 31, 2005. The
      decrease is primarily attributed to a $0.3 million reduction in personnel
      expenses partially offset by a $0.1 million increase in project expenditures
      in
      our IMRT/IGRT business.





**Amortization
      of intangible assets** .
      Amortization of intangible assets decreased $0.4 million, or 73%, to $0.2
      million for the three months ended July 31, 2006 from $0.6 million for the
      three
      months ended July 31, 2005. The decrease is attributed to the write-down of
      certain intangible assets in the fourth quarter of 2005.





**Interest
      and other income, net.** Interest
      expense was $84,000 for the three months ended July 31, 2006, compared to
      interest income of $23,000 for the three months ended July 31, 2005. The
      interest expense in fiscal 2006 resulted from the short-term and long-term
      debt
      and amortization of warrants, and the interest income in fiscal 2005 was due
      to
      a portfolio of marketable securities.





**Nine
      Months Ended July 31, 2006 Compared to Nine Months Ended July 31,
      2005**





**Revenue** .
      Revenue
      decreased $2.7 million, or 11%, to $22.7 million for the nine months ended
      July
      31, 2006, from $25.4 million for the nine months ended July 31, 2005. The
      decrease in revenue during the nine months ended July 31, 2006, is due to
      declines in IMRT/IGRT product revenue ($1.0 million) and IMRT/IGRT service
      revenue ($2.0 million) partially offset by an increase in our Radiation Sources
      revenue ($0.3 million).





Product
      revenue decreased $0.7 million, or 5%, to $15.6 million for the nine months
      ended July 31, 2006, from $16.3 million for the nine months ended July 31,
      2005.
      The decrease in product revenue during the nine months ended July 31, 2006,
      is
      largely due to a decline in unit sales of IMRT/IGRT products ($1.0 million)
      partially offset by an increase in Radiation Sources ($0.3 million).





Service
      revenue decreased $2.0 million, or 22%, to $7.1 million for the nine months
      ended July 31, 2006, from $9.1 million for the nine months ended July 31, 2005
      due to a decline in the number of maintenance agreements for IMRT/IGRT products.





**Gross
      profit** .
      Gross
      profit decreased $1.7 million, or 17%, to $8.3 million for the nine months
      ended
      July 31, 2006, from $10.0 million for the nine months ended July 31, 2005.
      The
      decrease in gross profit is attributed to declines in the product and service
      revenue in our IMRT/IGRT business ($1.3 million), and a product mix shift to
      lower margin palladium seeds and start-up costs of our in-house stranding
      operations in our Radiation Sources business ($0.4 million). Gross profit as
      a
      percentage of revenues decreased from 39% to 36% during this period.





Gross
      profit for the nine months ended July 31, 2006 consists of $5.7 million, or
      43%
      of revenue from our IMRT/IGRT business, and $2.6 million, or 28% of revenue
      from
      our Radiation Sources business. We expect gross margins in our Radiation Sources
      business to improve as we increase the number of brachytherapy seeds stranded
      in-house.





-24-




**Selling
      expenses** .
      Selling
      expenses include salaries, commissions and other related costs associated with
      our sales and marketing personnel and advertising, trade shows and other
      promotional programs. Selling expenses decreased $0.3 million, or 4%, to $6.2
      million for the nine months ended July 31, 2006, from $6.5 million for the
      nine
      months ended July 31, 2005. The decrease in selling expenses is primarily
      attributed to a reduction in personnel costs and a reduction in commission
      due
      to lower sales during the nine months ended July 31, 2006.





**General
      and administrative expenses** .
      General
      and administrative (“G&A”) expenses include salaries and other related costs
      associated with finance, executive, human resources and information technology
      personnel and other administrative costs. G&A expenses increased $0.3
      million, or 4%, to $8.3 million for the nine months ended July 31, 2006, from
      $8.0 million for the nine months ended July 31, 2005. The increase is primarily
      attributed to a $0.9 million increase in litigation-related legal fees, $0.1
      million for settlement of lawsuits and $0.7 million in stock compensation
      expense as a result of the implementation of SFAS 123R which requires the
      expensing of stock options being partially offset by $0.9 million reduction
      in
      personnel expenses and a $0.5 million reduction in bad debt
      expense.




**Research
      and development expenses** .
      Research and development (“R&D”) expenses include salaries and other related
      costs associated with product development, third party development costs,
      overhead costs and material used in development of prototypes. Our R&D costs
      decreased $0.7 million, or 16%, to $4.1 million for the nine months ended July
      31, 2006, from $4.8 million for the nine months ended July 31, 2005. The
      decrease is primarily attributed to $1.0 million reduction in personnel expenses
      in our IMRT/IGRT business partially offset by a $0.3 million increase in our
      Radiation Sources segment due to increased personnel expenses and project
      expenditures relating to in-house stranding and breast
      brachytherapy.





**Amortization
      of intangible assets** .
      Amortization of intangible assets decreased $1.2 million, or 73%, to $0.5
      million for the nine months ended July 31, 2006 from $1.7 million for the nine
      months ended July 31, 2005. The decrease is attributed to the write-down of
      certain intangible assets in the fourth quarter of 2005.





**Interest
      and other income, net.** Interest
      expense was $0.2 million for the nine months ended July 31, 2006, compared
      to
      interest income of $0.1 million for the nine months ended July 31, 2005. The
      interest expense in fiscal 2006 resulted from the short-term and long-term
      debt
      and amortization of warrants, and the interest income in fiscal 2005 was due
      to
      a portfolio of marketable securities.


**Liquidity
      and Capital Resources**





To
      date,
      our short-term liquidity needs have generally consisted of working capital
      to
      fund our ongoing operations and to finance growth in inventories, trade accounts
      receivable, new product research and development, capital expenditures,
      acquisitions and strategic investments in related businesses.  We have
      satisfied these needs primarily through a combination of cash generated by
      operations, public offerings, private placements of our common stock and
      issuance of debt.  We expect that we will be able to satisfy our
      longer term liquidity needs for research and development, capital expenditures,
      and acquisitions through a combination of cash generated by operations, public
      offerings, private placements of our common stock and issuance of
      debt.





The
      accompanying financial statements have been prepared on a going concern basis,
      which contemplates the realization of assets and liquidation of liabilities
      in
      the normal course of business. However, the Company has continued to incur
      substantial net losses and used substantial amounts of cash. As of July 31,
      2006, the Company has an accumulated deficit of $121.4 million, cash, cash
      equivalents and investments in marketable securities of $14.4 million and no
      debt.





-25-




Based
      on
      our current operating plans, we believe that the existing cash resources and
      cash forecasted by our plans to be generated by operations, as well as our
      anticipated and available lines of credit, will be sufficient to meet working
      capital and capital requirements through at least the next twelve months.
 Also, our plans to attain profitability and generate additional cash flows
      include increasing revenues from existing and new products and services and
      a
      focus on cost control.  However, there is no assurance that we will be
      successful with these plans.  If events and circumstances occur such that
      we do not meet our current operating plans as expected, and we are unable to
      raise additional debt or equity financing, we may be required to further reduce
      expenses or take other steps which could have a material adverse effect on
      our
      future performance, including but not limited to, the premature sale of some
      or
      all of the Company’s assets or product lines on undesirable terms, merger with
      or acquisition by another company on unsatisfactory terms, or the cessation
      of
      operations.





On
      July
      31, 2006, we had cash, cash equivalents, and investments in marketable
      securities aggregating approximately $14.4 million, an increase of approximately
      $10.8 million from $3.6 million at October 31, 2005. The increase was primarily
      attributed to approximately $22.0 million in cash received from the sale of
      common stock and warrants, net of approximately $2.0 million of expenses, and
      $0.2 in cash received from the employee stock purchase plan, partially offset
      by
      $11.0 million used in continuing operations, $0.1 million used in our
      discontinued operation and $0.3 million used for capital
      expenditures.





Cash
      used
      in operating activities increased $1.8 million, or 19%, to $11.0 million for
      the
      nine months ended July 31, 2006 from $9.2 million for the nine months ended
      July
      31, 2005. The increase in cash used in operating activities is primarily
      attributable to an increase in our net loss adjusted for non-cash items ($0.5
      million), an increase in accounts receivable ($0.9 million), and an increase
      in
      inventory ($1.2 million) partially offset by a lesser change in deferred revenue
      ($0.7 million) and a reduction in cash used in discontinued operations ($0.5
      million). We expect that cash used in operating activities may fluctuate in
      future periods as a result of a number of factors, including fluctuations in
      our
      operating results, accounts receivable collections, inventory management,
      research and development expenses, and the timing of payments.





Cash
      used
      in investing activities was $9.3 million for the nine months ended July 31,
      2006
      compared to cash provided by investing activities of $8.8 million for the nine
      months ended July 31, 2005. The cash used in fiscal year 2006 was attributable
      to the purchase of marketable securities. The cash provided in fiscal year
      2005
      is attributable to having drawn down our balance of marketable securities prior
      to the end of fiscal year 2005 to fund operations.





Cash
      provided by financing activities increased $21.4 million to $22.1 million for
      the nine months ended July 31, 2006, from $0.7 million for the nine months
      ended
      July 31, 2005. The increase is attributable to approximately $22.0 million
      in
      cash received from the sale of common stock and warrants, net of approximately
      $2.0 million of expenses, partially offset by a reduction in proceeds from
      the
      exercise of employee stock options and stock purchase plan ($0.6
      million).





We
      currently have $3.4 million in operating lease obligations for facilities and
      equipment under non-cancelable operating lease agreements. We have also entered
      into purchase commitments to suppliers under blanket purchase orders in the
      amount of $0.1 million.





**Critical
      Accounting Policies**





The
      preparation of financial statements and related disclosures in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make judgments, assumptions and estimates that affect
      the
      amounts reported in the Consolidated Financial Statements included in the
      Company’s Form 10-K for the year ended October 31, 2005, and accompanying notes.
      Note 1 to the Consolidated Financial Statements describes the significant
      accounting policies and methods used in the preparation of the Consolidated
      Financial Statements. Estimates are used for, but not limited to, the accounting
      for revenue recognition, allowance for doubtful accounts, inventory reserves,
      share-based compensation under FAS 123(R), goodwill and long-lived asset
      impairments, loss contingencies, and taxes. Estimates and assumptions about
      future events and their effects cannot be determined with certainty. We base
      our
      estimates on historical experience and on various other assumptions believed
      to
      be applicable and reasonable under the circumstances. These estimates may change
      as new events occur, as additional information is obtained and as our operating
      environment changes. These changes have historically been minor and have been
      included in the consolidated financial statements as soon as they became known.
      The following critical accounting policies are impacted significantly by
      judgments, assumptions and estimates used in the preparation of the Consolidated
      Financial Statements and actual results could differ materially from the amounts
      reported based on these policies.





-26-




*Revenue
      Recognition*




The
      Company sells products and services for radiation therapy treatment of cancer,
      including intensity modulated radiation therapy (“IMRT”), image guided radiation
      therapy (“IGRT”), as well as brachytherapy. Product revenue consists of
      brachytherapy seeds and accessories, non-therapeutic sources, and certain IMRT
      hardware devices, including our MiMIC and Crane products. Software revenues
      consist of IMRT treatment planning software, including Corvus, Peregrine and
      Peacock, and our IGRT products. Service revenue consists of warranty revenue
      and
      maintenance service agreements.




*Product
      revenue*




We
      apply
      the provisions of SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue
      Recognition” for the sale of non-software products.  SAB No. 104 which
      supersedes SAB No. 101, “Revenue Recognition 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 and provides guidance for the disclosure of revenue
      recognition policies.  In general, we recognize revenue related 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.




*Software
      revenue*




Our
      software product revenue is generated from the sale of advanced medical
      equipment products. The software element of our products is deemed an essential
      element of the functionality of the product. Maintenance and support are
      provided with the initial product sale for a twelve month period. The
      maintenance and support is renewable annually or longer, at the customer’s
      discretion.




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




Our
      software sales are generally multiple element arrangements, which could include
      the product, first year annual maintenance and support, and training and
      installation.  Revenues from the multiple element arrangements are
      allocated to each element based on the relative fair value of the
      elements.  If the fair value of the element exists, the determination is
      based on vendor specific objective evidence.  If such evidence of fair
      value for each element of the arrangement does not exist, all revenue from
      the
      arrangement is deferred until such time that evidence of fair value of each
      element 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
      more
      of the undelivered elements, the residual method of accounting is applied. 
Under the residual method, the fair value of the undelivered elements is
      deferred, and the remaining portion of the arrangement fee is recognized as
      revenue.




-27-





*Service
      revenue*




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




*Allowance
      for Doubtful Accounts and Sales Returns*





The
      allowance for doubtful accounts is based on our assessment of the collectibility
      of specific customer accounts and the aging of the accounts receivable. We
      regularly review the allowance by considering factors such as historical
      experience, age of the accounts receivable balances and current economic
      conditions that may affect a customer's ability to pay. If there was a
      deterioration of a major customer's credit worthiness or actual defaults are
      higher than our historical experience, our estimates of the recoverability
      of
      amounts due us could be overstated which could have an adverse impact on our
      financial results.





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





*Inventory
      Reserves*





Inventories
      are valued at the lower of cost or market as determined under the first-in,
      first-out method. Costs include materials, labor and manufacturing
      overhead.





The
      Company's Radiation Sources products are subject to shelf-life expiration
      periods, which are carefully monitored by the Company. Provision is made for
      inventory items which may not be sold because of expiring dates. The Company
      routinely reviews other inventories for evidence of impairment of value and
      makes provision as such impairments are identified.





*Goodwill
      and Other Intangible Assets*





SFAS
      142,
      Goodwill and Other Intangible Assets, requires that goodwill be tested for
      impairment at the reporting unit level (operating segment level or one level
      below an operating segment) on an annual basis (August 31st) and between annual
      tests if an event occurs or circumstances change that would more likely than
      not
      reduce the fair value of a reporting unit below its carrying value. These events
      or circumstances could include a significant change in the business climate,
      legal factors, operating performance indicators, competition, sale or
      disposition of a significant portion of a reporting unit. Application of the
      goodwill impairment test requires management to make various judgments,
      including the identification of reporting units, assignment of assets and
      liabilities to reporting units, assignment of goodwill to reporting units,
      and
      determination of the fair value of each reporting unit. The fair value of each
      reporting unit is estimated using a discounted cash flow methodology. This
      requires significant judgments including estimation of future cash flows, which
      is dependent on internal forecasts, estimation of the long-term rate of growth
      for our business, the useful life over which cash flows will occur, and
      determination of our weighted average cost of capital. Changes in these
      estimates and assumptions could materially affect the determination of fair
      value and/or goodwill impairment for each reporting unit.




-28-




*Research
      and Development Costs*





We
      account for research and development costs in accordance with several accounting
      pronouncements, including SFAS 2, Accounting for Research and Development Costs,
      and SFAS 86, Accounting for the Costs of Computer Software to be Sold, Leased,
      or Otherwise Marketed. SFAS 86 specifies that costs incurred internally in
      researching and developing a computer software product should be charged to
      expense until technological feasibility has been established for the product.
      Once technological feasibility is established, all software costs should be
      capitalized until the product is available for general release to customers.
      Judgment is required in determining when technological feasibility of a product
      is established. We have determined that technological feasibility for our
      software products is reached shortly before the products are released to
      manufacturing. Costs incurred after technological feasibility is established
      are
      not material, and accordingly, we expense all research and development costs
      when incurred.





*Loss
      Contingencies*





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





*Income
      Taxes*





We
      account for income taxes using the liability method. Deferred taxes are
      determined based on the differences between the financial statement and tax
      bases of assets and liabilities, using enacted tax rates in effect for the
      year
      in which the differences are expected to reverse. Valuation allowances are
      established when necessary to reduce deferred tax assets to the amounts expected
      to be realized. In addition, we are subject to examination of our income tax
      returns by the Internal Revenue Service and other tax authorities. We regularly
      assess the likelihood of adverse outcomes resulting from these
      examinations.





**Recent
      Accounting Pronouncements**





In
      June
      2006, the FASB issued Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes — An Interpretation of FASB Statement
      No. 109,* (FIN 48).  FIN 48 clarifies the accounting for uncertainty in
      income taxes recognized in an enterprise’s financial statements in accordance
      with FASB Statement No. 109, *Accounting
      for Income Taxes.* FIN 48 also prescribes a recognition threshold and measurement attribute
      for the financial statement recognition and measurement of a tax position taken
      or expected to be taken in a tax return that results in a tax benefit.
      Additionally, FIN 48 provides guidance on de-recognition, income statement
      classification of interest and penalties, accounting in interim periods,
      disclosure, and transition. This interpretation is effective for fiscal years
      beginning after December 15, 2006. The Company is currently evaluating the
      effect that the application of FIN 48 will have on its results of
      operations and financial condition





-29-




In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
      Financial Instruments” (“SFAS 155”), which amends SFAS No. 133, “Accounting for
      Derivatives Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 140,
“Accounting for Transfers and Servicing of Financial Assets and Extinguishment
      of Liabilities” (“SFAS 140).  SFAS 155 amends SFAS 133 to narrow the scope
      exception for interest-only and principal-only strips on debt instruments to
      include only such strips representing rights to receive a specified portion
      of
      the contractual interest or principle cash flows.  SFAS 155 also amends
      SFAS 140 to allow qualifying special-purpose entities to hold a passive
      derivative financial instrument pertaining to beneficial interests that itself
      is a derivative instruments.  SFAS No. 155 is effective for all financial
      instruments acquired or issued after the beginning of an entity’s first fiscal
      year that begins after September 15, 2006. The
      Company does not believe that SFAS No. 155 will have a material impact on the
      Company’s financial position, results of operations or cash flows.





In
      March
      2006, the FASB issued SFAS No. 156, “ Accounting
      for Servicing of Financial Assets” (“SFAS NO. 156”), which provides an approach
      to simplify efforts to obtain hedge-like (offset) accounting. This Statement
      amends FASB Statement No. 140, “Accounting for Transfers and Servicing of
      Financial Assets and Extinguishments of Liabilities”, with respect to the
      accounting for separately recognized servicing assets and servicing liabilities.
      The Statement (1) requires an entity to recognize a servicing asset or servicing
      liability each time it undertakes an obligation to service a financial asset
      by
      entering into a servicing contract in certain situations; (2) requires that
      a
      separately recognized servicing asset or servicing liability be initially
      measured at fair value, if practicable; (3) permits an entity to choose either
      the amortization method or the fair value method for subsequent measurement
      for
      each class of separately recognized servicing assets or servicing liabilities;
      (4) permits at initial adoption a one-time reclassification of
      available-for-sale securities to trading securities by an entity with recognized
      servicing rights, provided the securities reclassified offset the entity’s
      exposure to changes in the fair value of the servicing assets or liabilities;
      and (5) requires separate presentation of servicing assets and servicing
      liabilities subsequently measured at fair value in the balance sheet and
      additional disclosures for all separately recognized servicing assets and
      servicing liabilities. SFAS No. 156 is effective for all separately recognized
      servicing assets and liabilities as of the beginning of an entity’s fiscal year
      that begins after September 15, 2006, with earlier adoption permitted in certain
      circumstances. The Statement also describes the manner in which it should be
      initially applied. The Company does not believe that SFAS No. 156 will have
      a
      material impact on its financial position, results of operations or cash
      flows.





**Item
      3.**  **Quantitative
      and Qualitative Disclosures about Market Risk**




Information
      about market risks for the three and nine months ended July 31, 2006, does
      not
      differ materially from that discussed under Item 7A of our Annual Report on
      Form
      10-K for the fiscal year ended October 31, 2005.




**Item
      4.**  **Controls
      and Procedures**




(a)
      Evaluation of Disclosure Controls and Procedures





As
      required by Rule 13a-15(b) under the Securities and Exchange Act of 1934
      (the “Exchange Act”), we have carried out an evaluation, under the supervision
      and with the participation of our management, including our Chief Executive
      Officer (“CEO”) and our Chief Financial Officer (“CFO”), of the effectiveness,
      as of the end of the fiscal quarter covered by this report, of the design and
      operation of our “disclosure controls and procedures” as defined in
      Rule 13a-15(e) promulgated by the SEC under the Exchange Act. Based upon
      that evaluation, our CEO and our CFO concluded that our disclosure controls
      and
      procedures, as of the end of such fiscal quarter, were adequate and effective
      to
      ensure that information required to be disclosed by us in the reports that
      we
      file or submit under the Exchange Act is recorded, processed, summarized and
      reported within the time periods specified in the Commission’s rules and forms
      and that such information is accumulated and communicated to our management,
      including our CEO and CFO, as appropriate to all timely decisions regarding
      required disclosure.





-30-




(b)
      Changes in Internal Controls





There
      has
      been no change in our internal control over financial reporting during the
      quarter ended July 31, 2006, that has materially affected or is reasonably
      like
      to materially affect our internal control over financial reporting.





**PART
      II - OTHER INFORMATION**





**Item
      1. Legal Proceedings**





On
      April
      20, 2006, a lawsuit captioned *J.P.
      Morgan Trust Company, N.A. v. John Alan Friede, et al.* was
      filed in the U.S. District Court for the Southern District of New York against
      John A. Friede, a current director and stockholder of North American Scientific,
      Inc. (“NASI”), Mr. Friede’s wife, and NOMOS Corporation, a subsidiary of NASI.
      The plaintiff, J.P. Morgan Trust Company, filed the lawsuit in its capacity
      as
      personal representative of the Estate of Evelyn A.J. Hall, Mr. Friede’s deceased
      mother. The complaint as amended on August 8, 2006 asserts claims for
      reimbursement and contribution, constructive fraud, breach of contract and
      other
      related claims arising out of loans made by Mrs. Hall to, or for the benefit
      of,
      Mr. and Mrs. Friede and/or NOMOS, or acting as an accommodation party in
      additional loans made to Mr. and Mrs. Friede by financial institutions that
      were
      not subsequently repaid. During the time periods alleged in the complaint,
      Mr.
      Friede was the Chairman, Chief Executive Officer and the largest stockholder
      of
      NOMOS. With respect to NOMOS, the complaint seeks at least approximately
      $5,250,000 principal amount of loans allegedly made to and still outstanding
      and
      owed by NOMOS, and other related equitable remedies plus interest, costs and
      expenses.





On
      the
      basis of copies of documents that have been made available to us, we believe
      that the claims made against NOMOS in the lawsuit appear to be without merit
      and
      we intend to vigorously defend against them. However, in accordance with the
      indemnification provisions of the merger agreement under which we acquired
      NOMOS
      on May 4, 2004, and the related indemnity escrow agreement, we have made a
      claim
      for indemnification against the escrow to preserve our right of indemnity.
      Under
      these provisions, an indemnifying party will not have any indemnification
      obligations until such time as the aggregate indemnified losses for which we
      are
      entitled to indemnification equals or exceeds $400,000, at which point, the
      indemnifying party will be liable for the full amount of all such indemnified
      losses without regard to the $400,000 basket. As of the date hereof, the
      indemnity escrow account holds approximately $1,225,000 of cash and 526,810
      shares of our common stock. We also intend to review various other legal
      remedies that may be available to us.




The
      Company is also subject to other legal proceedings, claims and litigation in
      addition to those discussed above and in Note 12. While the outcome of these
      matters is currently not determinable, the ultimate costs to resolve these
      matters, including, notably, the cost of litigation, has had and may continue
      to
      have a material adverse effect on the Company's consolidated financial position,
      results of operations, or cash flows.





-31-




**Item
      1A. Risk Factors**





*We
      operate in a rapidly changing environment that involves a number of risks,
      some
      of which are beyond our control. This discussion highlights some of the risks
      that may affect future operating results. The risks described below are not
      the
      only ones facing us. Additional risks and uncertainties not presently known
      to
      us, which we currently deem immaterial or which are similar to those faced
      by
      other companies in our industry or business in general, may also impair our
      business operations. If any of the following risks or uncertainties actually
      occurs, our business, financial condition and operating results would likely
      suffer.*




**We
      have experienced significant losses and may continue to incur such losses in
      the
      future. As a result, we have used a significant amount of our cash, cash
      equivalents, and investments in marketable securities. We recently raised net
      proceeds of approximately $22 million in a private placement of our common
      stock; however, if we continue to incur significant losses and are unable to
      access additional capital, we will be unable to adequately fund future
      operations and operate as a going concern.**





We
      have
      incurred substantial net losses in each of the last six fiscal years, and in
      the
      nine months ended July 31, 2006. As reflected in our financial statements in
      our
      Annual Report on Form 10-K, we have experienced net losses of $55.5 million,
      $36.3 million, and $9.4 million in our fiscal years ended October 31, 2005,
      2004
      and 2003, respectively, and a net loss of $11.0 million in the nine months
      ended
      July 31, 2006. As a result, the amount of our cash, cash equivalents, and
      investments in marketable securities has significantly declined from
      approximately $49.1 million at October 31, 2003 to $14.4 million at July 31,
      2006. The decrease over the two year period ended October 31, 2005, was
      primarily attributed to net cash payments of $26.3 million used in continuing
      operating activities, $13.2 million related to our acquisition of NOMOS, $9.0
      million used in the discontinued Theseus operations, and $1.6 million used
      for
      capital expenditures, partially offset by $4.6 million in cash received from
      the
      exercise of stock options and our employee stock purchase plan. The increase
      of
      $10.8 million in the nine months ended July 31, 2006 was primarily due to $22.0
      million in cash received from the sale of common stock and warrants, net of
      $2.0
      million of expenses, and $0.2 in cash received from the employee stock purchase
      plan, partially offset by $11.0 million used in continuing operations, $0.1
      million used in our discontinued operation and $0.3 million used for capital
      expenditures.





The
      negative cash flow we have sustained has materially reduced our working capital,
      which in turn, could materially and negatively impact our ability to adequately
      fund future operations and continue to operate as a going concern. Management
      has and continues to take actions intended to improve our results. These actions
      include reducing cash operating expenses, developing new technologies and
      products, improving existing technologies and products, and expanding into
      new
      geographical markets. **** The
      availability of necessary working capital, however, is subject to many factors
      beyond our control, including, our ability to obtain favorable financing,
      economic cycles, market acceptance of our products, competitors’ responses to
      our products, the intensity of competition in our markets, the level of demand
      for our products.





The
      amount of working capital that we will need in the future will also depend
      on
      our efforts and many factors, including:





•
            Our
                ability to successfully market and sell our
                products;


•
            Continued
                scientific progress in our discovery and research
                programs;


•
            Levels
                of sales and marketing that will be required to launch future products
                and
                achieve and maintain a competitive position in the marketplace for
                both
                existing and new products;


•
            Levels
                of inventory and accounts receivable that we
                maintain;


•
            Level
                of capital expenditures;


•
            Acquisition
                or development of other businesses, technologies or
                products;


•
            The
                time and costs involved in obtaining regulatory approvals;






-32-




•
            The
                costs involved in preparing, filing, prosecuting, maintaining, defending,
                and enforcing patent claims; and


•
            The
                potential need to develop, acquire or license new technologies and
                products.





If
      we are
      unsuccessful in these efforts or if any or some of these factors negatively
      impact us, we will need to raise additional capital, reduce operations or take
      other steps to achieve positive cash flow. Although we cannot assure you that
      we
      will be successful in these efforts or that any or some of these factors will
      not negatively impact us currently, we believe we will have sufficient cash
      to
      sustain us through
      at least the next twelve months .





**Success
      of our recently announced plans to develop a breast brachytherapy product will
      be dependent upon a variety of factors.**





We
      recently announced the development of a new brachytherapy product for the
      treatment of breast cancer. We expect that this product may generate significant
      revenues in the future; however, there are a number of factors which could
      adversely affect our ability to achieve this goal, including:




·
            Successful
                completion of the development and launch of this product, including
                receiving all necessary regulatory
                approvals;


·
            Our
                ability to protect our intellectual property through patents and
                licenses;


·
            Our
                ability to successfully manufacture production quantities of the
                product;


·
            The
                acceptance of the product by physicians and health professionals;
                and


·
            Our
                ability to hire and train a direct sales force to sell the
                product;




**We
      may be required to record additional goodwill impairment in the
      future.**




Under
      SFAS 142 and SFAS 144, goodwill and intangible assets having an indefinite
      life
      are not amortized but are subject to testing at least annually or more often
      if
      an event occurs or circumstances indicate that the carrying values for goodwill
      and/or intangible assets may be impaired, using a fair value based approach.
      Accounting for impairment contains uncertainty because management must use
      judgment in determining appropriate assumptions to be used in the measurement
      of
      fair value. The Company engaged an appraisal firm to perform an analysis of
      the
      goodwill and intangible assets acquired from NOMOS, to determine the fair value
      thereof under the applicable standards as of the Company’s annual test date of
      September 30, 2005. As a result of this testing, in the fourth quarter of 2005,
      the Company recorded impairments of goodwill and intangible assets of NOMOS
      in
      the amount of $39,884,000, and impairments of goodwill and intangible assets
      of
      Radiation Therapy Products (“RTP”) in the amount of $329,000, in each case due
      to negative operating performance indications including declining sales and
      continued operating losses of the respective business segments.




The
      Company will continue to monitor impairment indicators in any of our reporting
      segments. If our future financial performance or other events indicate that
      the
      value of our recorded goodwill or intangible assets is further impaired, we
      may
      record additional impairment charges that could have a material adverse effect
      on our reported results.




**All
      of our product lines are subject to intense competition. Our most significant
      competitors have significantly greater resources than we do. As a result, we
      cannot be certain that our competitors will not develop superior technologies
      or
      otherwise be able to compete against us more effectively. If we fail to maintain
      our competitive position in key product areas, we may lose significant sources
      of revenue.**




We
      expect
      that our intensity-modulated radiation therapy, or IMRT, and image-guided
      radiation therapy, or IGRT, product lines, including CORVUS, PEACOCK and BAT,
      will generate a substantial part of our revenues in fiscal year 2006. We will
      need to continue to develop enhancements to these products and improvements
      on
      our core technologies in order to compete effectively. Rapid change and
      technological innovation characterize the marketplace for medical products,
      and
      our competitors could develop technologies that are superior to our products
      or
      that render such products obsolete. We anticipate that expenditures for research
      and development will continue to be significant. The domestic and foreign
      markets for radiation therapy equipment are highly competitive. Many of our
      competitors and potential competitors have substantial installed bases of
      products and significantly greater financial, research and development,
      marketing and other resources than we do. Competition may increase as emerging
      and established companies enter the field. In addition, the marketplace could
      conclude that the tasks our products were designed to perform are no longer
      elements of a generally accepted treatment regimen. This could result in us
      having to reduce production volumes or discontinue production of one or more
      IMRT/IGRT products.




-33-




Our
      single largest competitor in the IMRT/IGRT market is Varian Medical
      Systems, Inc. (“Varian”). Varian is the largest worldwide manufacturer, in
      terms of market share, of linear accelerators. Linear accelerators are the
      machines that generate the radiation energy beams used in both IMRT and
      conventional radiation treatment. Varian also markets its own line of IMRT
      products, including several models of multileaf collimators and an IMRT inverse
      planning software package, which it often includes with its linear accelerators.
      Varian is also one of the principal providers of record and verification
      systems, which are systems that keep track of all critical information in the
      treatment of radiation therapy patients and which allow the planning system
      to
      communicate with the linear accelerator. Varian acquired Zmed, Inc., one of
      our principal competitors for BAT. Varian expects the acquisition to enhance
      its
      3-D ultrasound imaging capabilities and offer radiation oncology departments
      a
      new line of stereotactic positioning accessories and planning software, allowing
      Varian to directly compete against BAT.




We
      also
      compete with Siemens and Elekta, each of which manufactures one or more
      multileaf collimators that compete with MIMiC and, therefore, with our
      integrated system, PEACOCK. There are several other companies that currently
      offer or plan to offer IMRT modules, which typically add IMRT functionality
      to
      conventional radiation treatment planning products.




Finally,
      we compete with all manufacturers of conventional radiation therapy products
      many of which are devoting substantial resources to promoting their products.




Our
      brachytherapy business is also subject to intense competition. Our primary
      competitors in the brachytherapy seed business include: Nycomed Amersham PLC
      (through its control of Oncura) and C.R. Bard, Inc., both of whom
      manufacture and sell Iodine-125 brachytherapy seeds, as well as distribute
      Palladium-103 seeds manufactured by a third party (in the case of Oncura, we
      currently manufacture a portion of its Palladium-103 seed requirements pursuant
      to a distribution agreement reached in July 2005); Coloplast A/S (through its
      purchase of Mentor’s urology business), which manufactures and sells Iodine-125
      brachytherapy seeds and currently distributes third party manufactured
      Palladium-103 brachytherapy seeds; and Theragenics Corporation, which
      manufacturers Palladium-103 seeds and sells Palladium-103 and Iodine-125
      brachytherapy seeds directly and its Palladium-103 brachytherapy seeds through
      marketing relationships with third parties. Several additional companies
      currently sell brachytherapy seeds as well. Recent market changes have also
      provided additional competition for brachytherapy-related services, such as
      pre-loading needles with seeds and placing seeds in so-called “strands.”





Our
      radiation reference source business also is subject to intense competition.
      Competitors in this industry include AEA Technology PLC and Eckert &
Ziegler AG. We believe that these companies have a dominant position in the
      market for radiation reference source products.





Because
      we are a relatively small company, there is a risk that potential customers
      will
      purchase products from larger manufacturers, even if our products are
      technically superior, based on the perception that a larger, more established
      manufacturer may offer greater certainty of continued product improvements,
      support and service, which could cause our revenues to decline. In addition, many
      of
      our competitors are substantially larger and have greater sales, marketing
      and
      financial resources than we do. Developments by any of these or other companies
      or advances by medical researchers at universities, government facilities or
      private laboratories could render our products obsolete. Moreover, companies
      with substantially greater financial resources, as well as more extensive
      experience in research and development, the regulatory approval process,
      manufacturing and marketing, may be in a better position to seize market
      opportunities created by technological advances in our industry.





-34-




**We
      are highly dependent on our direct sales organization, which is small compared
      to many of our competitors and which has relatively limited marketing and sales
      experience in our products. We have also experienced a high degree of turnover
      in our sales organization. Any failure to build, manage and maintain our direct
      sales organization could negatively affect our revenues.**




Our
      current domestic direct sales force is small relative to many of our
      competitors. There is intense competition for skilled sales and marketing
      employees, particularly for people who have experience in the radiation oncology
      market. Accordingly, we could find it difficult to hire or retain skilled
      individuals to sell our products. Any failure to build our direct sales force
      could adversely affect our growth and our ability to meet our revenue goals.




We
      have
      experienced a higher than anticipated turnover in our domestic direct sales
      force which has resulted in a relative lack of experience in selling our
      products. As a result of our relatively small sales force, the intense
      competition for skilled sales and marketing employees ,
      and the
      high turnover in our sales force, there can be no assurance that our direct
      sales and marketing efforts will be successful. If we are not successful in
      our
      direct sales and marketing, our sales revenue and results of operations are
      likely to be materially adversely affected.




**We
      depend partially on our relationships with distributors and other industry
      participants to market some of our products, and if these relationships are
      discontinued or if we are unable to develop new relationships, our revenues
      could decline.**




We
      currently rely, and will continue to rely, upon collaborative relationships
      with
      agents and distributors and other industry participants to maintain IMRT/IGRT
      market access to potential customers, particularly in Asia and Europe, and
      our
      business strategy includes entering into more of these relationships in the
      future. Some of the entities with whom we have relationships to help market
      and
      distribute our products also produce or distribute products that directly
      compete with our IMRT/IGRT products.




We
      cannot
      assure you that we will be able to maintain or develop these relationships
      with
      agents and distributors and other industry participants or that these
      relationships will continue to be successful. If any of these relationships
      are
      terminated, not renewed or otherwise unsuccessful, or if we are unable to
      develop additional relationships, our product sales could decline, and our
      ability to grow our IMRT/IGRT business could be adversely affected. This is
      particularly the case with respect to foreign sales of our IMRT/IGRT products,
      where we currently rely, and we will continue to rely, on our distributors'
      expertise regarding foreign regulatory matters and their access to actual and
      potential customers.




In
      addition, our 2005 agreement with Oncura for distribution of our Palladium-103
      brachytherapy seeds may be an important component of that business.




We
      do not
      have a direct sales force for our non-therapeutic radiation source products,
      and
      rely entirely on the efforts of agents and distributors for sales of those
      non-brachytherapy products. We cannot assure you that we will be able to
      maintain our existing relationships with our agents and distributors for the
      sale of our non-therapeutic radiation source products.




**One
      of our primary markets in our IMRT product line is the market for upgrading
      linear accelerators that do not have IMRT capabilities to provide them with
      IMRT
      capabilities. This market will shrink over time, thereby limiting our potential
      revenues from the upgrading of linear accelerators.**




-35-




To
      date,
      a majority of our revenues from the sale of our IMRT products has been derived
      from the sale of these products to customers who decide to upgrade linear
      accelerators that do not have IMRT capabilities to enable them to deliver IMRT
      treatments. Most of these linear accelerators are older models. Selling CORVUS
      to customers with newer multileaf collimator-equipped linear accelerators can
      be
      difficult because these linear accelerators may be offered with IMRT planning
      software at little or no additional cost. Accordingly, to make a sale, we often
      must convince these potential customers that CORVUS is sufficiently superior
      to
      the IMRT or conventional radiation treatment planning software products offered
      by the manufacturer to justify the additional costs of purchase. Selling PEACOCK
      and MIMiC to potential customers with newer multileaf collimator-equipped linear
      accelerators is even more difficult because, in addition to the incremental
      costs of purchase, these potential customers may be reluctant to incur the
      additional effort required to retrofit the factory installed multileaf
      collimator with MIMiC. Over time, if more institutions purchase new linear
      accelerators that are IMRT-equipped or upgrade their older accelerators with
      technology from us or our competitors, the market for upgrading linear
      accelerators that do not have IMRT capabilities will shrink and may become
      saturated, which could adversely affect our sales and limit our potential
      revenues from our products.




**If
      we are unable to complete current developments or to develop new enhancements
      and new generations of IMRT/IGRT and/or brachytherapy products, we may be unable
      to retain our existing customers or attract new customers.**




Rapid
      and
      significant technological change, evolving industry standards and new product
      introductions characterize the market for our products. Many of our products
      are
      technologically innovative and require significant planning, design, development
      and testing. These activities require significant capital commitments and
      investment. If we are unable to raise needed capital on favorable terms or
      at
      all, we may be unable to maintain our competitive advantage in the marketplace.




New
      product developments in the healthcare industry are inherently risky and
      unpredictable. These risks include:




•
            failure
                to prove feasibility;


•
            time
                required from proof of feasibility to routine production;


•
            timing
                and cost of regulatory approvals and clearances;


•
            competitors'
                response to new product developments;


•
            manufacturing,
                installation, warranty and maintenance cost overruns;


•
            failure
                to obtain customer acceptance and payment;


•
            customer
                demands for retrofits of both old and new products; and


•
            excess
                inventory caused by phase-in of new products and phase-out of old
                products.




The
      high
      cost of technological innovation is coupled with rapid and significant change
      in
      the regulations governing the products that compete in our market, by industry
      standards that could change on short notice, and by the introduction of new
      products and technologies that could render existing products and technologies
      uncompetitive. We cannot be sure that we will be able to successfully develop
      new products or enhancements to our existing products. Without successful new
      product introductions, our revenues will likely suffer. Even if customers accept
      new or enhanced products, the costs associated with making these products
      available to customers, as well as our ability to obtain capital to finance
      such
      costs, could reduce or prevent us from increasing our operating margins. On
      July
      24, 2006, we received FDA 510(k) clearance for our nomosSTAT product, which
      represents the next generation of our currently marketed PEACOCK product. The
      successful introduction of nomosSTAT is critical to our ability to achieve
      our
      sales targets for fiscal 2006. Any lack of acceptance in the market may result
      in a materially adverse impact on our financial results.




-36-





In
      addition, although we have received FDA 510(k) clearance for our PEREGRINE
      dose
      calculation software product, and it may now be used clinically to treat
      patients for one linear accelerator beam modifier combination, we are still
      in
      the process of finalizing the development of PEREGRINE in order to allow it
      to
      be used with a broader range of linear accelerators, energy levels with those
      linear accelerators, and treatment planning systems without the need for
      extensive commissioning and testing. An inability to complete these developments
      on a timely basis could adversely affect our relationship with the early
      purchasers of PEREGRINE, and could adversely impact our ability to sell
      PEREGRINE to new customers. Any failure to successfully complete these
      developments could also hurt our reputation and, therefore, adversely impact
      sales of other our products.




**We
      might not be able to make our IMRT products compatible with some existing linear
      accelerators and other radiation therapy products. In addition, any future
      changes in the configuration of the most common linear accelerators could
      require costly and time-consuming modifications to our products that could
      harm
      our business.**




Our
      IMRT
      products are designed to be used in conjunction with most linear accelerators
      currently in use. Our products are not currently compatible with all linear
      accelerators. However, when manufacturers modify the design or functionality
      of
      their machines, we are often required to modify our products to ensure
      compatibility. Future changes cannot be predicted and, in the case of changes
      initiated by linear accelerator manufacturers who are our competitors, could
      be
      made or timed to place us at a competitive disadvantage. Responding to these
      changes can be costly and time-consuming. In addition, we could be required
      to
      obtain additional regulatory clearances for any modifications of our products.
      It is also possible that, despite our best efforts, we might be unable to make
      our products compatible with new or modified versions of linear accelerators
      or
      might only be able to do so at a prohibitive expense.




Our
      PEREGRINE product is not currently fully compatible with the majority of the
      linear accelerators in the United States and worldwide markets. We cannot assure
      you that we will be successful in making PEREGRINE compatible with additional
      linear accelerators, and any future changes in the design of any linear
      accelerators could require us to redesign the functionality of PEREGRINE. We
      may
      not be successful at any such effort.




**If
      alternative technologies prove to be superior to IMRT/IGRT or brachytherapy,
      physician adoption of our products could substantially decrease.**




Our
      IMRT/IGRT products face competition from companies that sell conventional
      radiation therapy products as well as from companies that are developing,
      marketing and manufacturing alternative therapies to radiation for the treatment
      of solid tumor cancers. It is possible that advances in the pharmaceutical,
      bio-medical or gene-therapy fields could render some or all radiation therapies,
      whether conventional or based on IMRT/IGRT and brachytherapy, obsolete. Even
      incremental advances in competing technologies could result in the rejection
      of
      our products as a part of a generally accepted diagnostic or treatment regimen.
      If alternative therapies are proven or perceived to offer treatment options
      that
      are superior or more cost effective than the treatments our products provide,
      physician adoption of our products could be negatively affected and our revenues
      from our products could decline.




**There
      is currently a lack of long-term data regarding the safety and effectiveness
      of
      IMRT products and negative data or the continued lack of adequate supporting
      data could adversely affect market acceptance of our IMRT products.**




Although
      we estimate that our IMRT products have been used to treat thousands of patients
      worldwide, this is still a statistically small number, and these treatments
      have
      primarily involved tumors of the prostate, head, neck and spinal cord. Much
      of
      the data produced in current studies using IMRT and our products have involved
      small patient sample sizes, and any positive results of these studies may not
      be
      representative of the results that will be achieved in studies involving larger
      patient sample sizes. If we are unable to obtain additional and more
      comprehensive clinical studies, or if long-term clinical studies fail to confirm
      the effectiveness of IMRT or our products, our sales could fail to increase
      or
      could decrease.




-37-





Some
      theoretical and non-clinical studies, meaning studies that are not based on
      significant empirical evidence, have suggested that the use of IMRT and
      potentially our products may cause serious negative side effects, such as a
      risk
      of induced cancer, as a result of the increased radiation delivered to the
      patient. At present, not enough time has passed to determine conclusively the
      long-term side effects. If future clinical studies confirm that these negative
      side effects occur as a result of IMRT treatments, our sales could fail to
      grow
      or could decline. In addition, if it is shown that our products cause harmful
      side effects, the U.S. Food and Drug Administration, or FDA, could require
      us to
      change our product labeling to describe these potential side effects or could
      even rescind the clearances for our products and potentially require a recall
      of
      our products.




IMRT,
      whether using our products or those of our competitors, requires a substantial
      departure from customary quality assurance practices. The complexity and dynamic
      nature of IMRT deliveries make new demands on patient plan and dose
      verification. These difficulties and departures from customary practices may
      impede market acceptance of IMRT in general and our products in particular,
      which could adversely affect our ability to increase sales of our products
      and
      achieve our desired growth rate.




**IMRT
      treatments expose patients to increased radiation leakage, which could
      potentially cause long-term deleterious side effects, including induced cancer.**




In
      both
      IMRT and conventional radiation therapy, there is radiation leakage, which
      means
      radiation that escapes from the linear accelerator and is absorbed by the
      patient outside the area of the patient's body being treated. Linear
      accelerators are the machines that generate the radiation energy beams used
      in
      both IMRT and conventional radiation treatment. Leakage occurs at all times
      when
      the linear accelerator is producing radiation. In IMRT treatments, the linear
      accelerator is required to produce radiation for a longer period of time overall
      as compared to conventional radiation treatments. Also, in IMRT treatments
      there
      is additional leakage that is transmitted through or between the leaves of
      the
      multileaf collimator itself. As a result, there is an increase in the overall
      radiation leakage to which the patient is exposed due to the longer periods
      of
      radiation delivery.




The
      increased radiation leakage associated with IMRT treatments could require
      additional room shielding to protect clinic personnel. In addition, concerns
      have been raised by some researchers that the increase in overall radiation
      leakage to which IMRT patients are exposed may have deleterious long-term
      effects, including the potential for inducing cancer.




These
      same studies suggest that an increase in the long-term risk of induced cancers
      from IMRT may be possible. The risk, or perceived risk, of induced cancers
      could
      slow or prevent expanded use of IMRT to treat additional types of cancers and
      could even result in decreased usage of IMRT to treat cancers currently treated
      with IMRT if the increased risk is shown or believed to be significant, which
      could cause our revenues from our products to decline and our business to
      suffer.




**Our
      IMRT/IGRT products are used in connection with the delivery of intense
      radiation. Defects in, or misuse of, our products, or any detrimental side
      effects that result from the use of our products, could result in serious injury
      or death and could require costly recalls or subject us to costly and
      time-consuming product liability claims. This could harm future sales and
      require us to pay substantial damages.**




Our
      IMRT/IGRT products are used in connection with the delivery of high-powered
      external beam radiation to cancer patients. One or more of our IMRT/IGRT
      products could malfunction or be misused and cause serious injury or death
      to a
      patient. In addition, our IMRT/IGRT products might otherwise be determined
      to
      cause serious injury or other detrimental side effects. There is an inherent
      risk in our industry that we could be sued if one of our products results in,
      or
      is alleged to result in, a personal injury. Although we believe that we
      currently have adequate insurance to address anticipated potential liabilities
      associated with product liability, any unforeseen product liability, exposure
      in
      excess of, or outside the scope of, such insurance coverage could adversely
      affect our operating results. Any such claim brought against us, with or without
      merit, could result in significant damage to our business.




-38-




The
      FDA's
      medical device reporting regulations require us to report any incident in which
      our products may have caused or contributed to a death or serious injury, or
      in
      which our products malfunctioned in a way that would be likely to cause or
      contribute to a death or serious injury if the malfunction recurred. Any
      required filing could result in an investigation of our products and possibly
      subsequent regulatory action against us if it is found that one of our products
      caused the death or serious injury of a patient.




Because
      of the nature of our IMRT/IGRT products and their use, the tolerance for error
      in the design, manufacture or use of our IMRT/IGRT products may be small or
      nonexistent. If a product designed or manufactured by us is defective, whether
      due to design or manufacturing defects, or improper assembly, use or servicing
      of the product or other reasons, the product may need to be recalled, possibly
      at our expense. Furthermore, the adverse effect of a product recall might not
      be
      limited to the cost of the recall. For example, a product recall could cause
      applicable regulatory authorities to investigate us as well as cause our
      customers to review and potentially terminate their relationships with us.
      Recalls, especially if accompanied by unfavorable publicity or termination
      of
      customer contracts, could cause us to suffer substantial costs, lost revenues
      and a loss of reputation, each of which could harm our business. Products as
      complex as our planning and dose calculation software systems may also contain
      undetected software errors or defects when they are first introduced or as
      new
      versions are released. Our products may not be free from errors or defects
      even
      after they have been tested, which could result in the rejection of our products
      by our customers and damage to our reputation, as well as lost revenue, diverted
      development resources and increased support costs. We may also be subject to
      claims for damages related to any errors in our products.




We
      currently maintain product liability insurance, which has deductible amounts
      and
      per claim and aggregate limits. However, we cannot assure you that this
      insurance will continue to be available on terms acceptable to us or in
      sufficient amounts if at all, or that it will provide adequate coverage in
      the
      event that any product liability is actually incurred.




**Currently,
      our products are predominantly used in the treatment of tumors of the prostate,
      head, neck and spinal cord. If we do not obtain wider acceptance of our products
      to treat other types of cancer, our sales could fail to increase and we could
      fail to achieve our desired growth rate.**




Currently,
      our IMRT/IGRT products are predominantly used in the treatment of tumors of
      the
      prostate, head, neck and spinal cord, while our brachytherapy products are
      used
      almost exclusively for the treatment of prostate cancer. Further research,
      clinical data and years of experience will likely be required before there
      can
      be broad acceptance for the use of both our IMRT/IGRT as well as our
      brachytherapy products for additional types of cancer. In particular, some
      recognized members of the radiation oncology community have expressed skepticism
      as to the relative benefits of IMRT treatments other than for limited types
      of
      cancer such as prostate cancer, where mortality is closely linked to recurrence
      of the local tumor. They point out that in many types of cancer, such as breast
      cancer, mortality is usually a result of metastasis, meaning the expansion
      of
      the cancer to other parts of the patient's body, and that eliminating or
      controlling the growth of the local tumor, which is the goal of IMRT treatments,
      does little to prevent this from occurring. If our products do not become more
      widely accepted in treating other types of cancer, our sales could fail to
      increase or could decrease.




**We
      rely on several sole source suppliers and a limited number of other suppliers
      to
      provide raw materials and significant components used in our products. A
      material interruption in supply could prevent or limit our ability to accept
      and
      fill orders for our products.**




-39-




Although
      we perform final product assembly of our IMRT/IGRT products, we purchase all
      major components for those products from third-party suppliers. We currently
      rely on a single source of supply for several key materials and components,
      the
      most important of which are the tungsten leaves used in our MIMiC multi-leaf
      collimator and all major components used in our BAT targeting system. We also
      obtain various other components for our IMRT/IGRT products from a limited number
      of sources. We cannot produce IMRT/IGRT products without these components.
      In
      the event of any extended or recurring interruption in supply, or if any of
      the
      significant components to our IMRT/IGRT products become obsolete or are no
      longer manufactured, we could be required to redesign our products or seek
      alternative supply sources, which could significantly impair our ability to
      sell
      these products. In some cases, we expect that it would take several months,
      or
      longer, for a new supplier to begin providing components to specification.
      In
      addition, we could be required to make a new or supplemental filing with the
      FDA
      and other applicable regulatory authorities and might have to obtain clearance
      or other regulatory approvals prior to marketing a product containing new
      components. We may be unable to obtain the necessary regulatory clearances
      or
      approvals on a timely basis, if at all, which could cause our revenues to
      decline and our business to suffer.





We
      also
      depend upon a limited number of outside unaffiliated suppliers for our
      radioisotopes. Our principal suppliers are Nordion International, Inc. and
      a company in Russia. We also utilize other commercial isotope manufacturers
      located in the United States and overseas. To date, we have been able to obtain
      the required radioisotopes for our products without any significant delays
      or
      interruptions. Currently, we rely exclusively upon Nordion International for
      our
      supply of the Palladium-103 isotope; if Nordion International ceases to supply
      isotopes in sufficient quantity to meet our needs, there may not be adequate
      alternative sources of supply. If we lose any of these suppliers (including
      any
      single-source supplier), we would be required to find and enter into supply
      arrangements with one or more replacement suppliers. Obtaining alternative
      sources of supply could involve significant delays and other costs and these
      supply sources may not be available to us on reasonable terms or at all. Any
      disruption of supplies could delay delivery of our products that use
      radioisotopes, which could adversely affect our business and financial results
      and could result in lost or deferred sales.




**If
      we are unable to attract and retain qualified employees, we may be unable to
      meet our growth and revenue needs.**




Our
      success is materially dependent on a limited number of key employees, and,
      in
      particular, the continued services of L. Michael Cutrer, our president and
      chief
      executive officer, and James W. Klingler, our chief financial officer. We carry
      key employee insurance for Mr. Cutrer in the amount of $2.5 million.
      Our future business and financial results could be adversely affected if the
      services of Messrs. Cutrer or Klingler or other key employees cease to be
      available. To our knowledge, none of our key employees have any plans to retire
      or leave in the near future.




Our
      future success and ability to grow our business will depend in part on the
      continued service of our skilled personnel and our ability to identify, hire
      and
      retain additional qualified personnel. Although some employees are bound by
      a
      limited non-competition agreement that they sign upon employment, few of our
      employees are bound by employment contracts, and it is difficult to find
      qualified personnel, particularly medical physicists and customer service
      personnel, who are willing to travel extensively. We compete for qualified
      personnel with medical equipment manufacturers, universities and research
      institutions. Because the competition for these personnel is intense, costs
      related to compensation may increase significantly.




Even
      when
      we are able to hire a qualified medical physicist, engineer or other technical
      person, there is a significant training period of up to several months before
      that person is fully capable of performing the functions we need. This could
      limit our ability to expand our business.




-40-




**The
      medical device industry is characterized by competing intellectual property,
      and
      we could be sued for violating the intellectual property rights of others.**




The
      medical device industry is characterized by a substantial amount of litigation
      over patent and other intellectual property rights. Our competitors, like
      companies in many high technology businesses, continually review other
      companies' products for possible conflicts with their own intellectual property
      rights. Determining whether a product infringes a patent involves complex legal
      and factual issues, and the outcome of patent litigation actions is often
      uncertain. Our competitors could assert that our products and the methods we
      employ in the use of our products are covered by United States or foreign patent
      rights held by them. In addition, because patent applications can take many
      years to issue, there could be applications now pending of which we are unaware,
      which could later result in issued patents that our products infringe. There
      could also be existing patents that one or more of our products could
      inadvertently be infringing of which we are unaware.




While
      we
      do not believe that any of our products, services or technologies infringe
      any
      valid intellectual property rights of third parties, we may be unaware of
      third-party intellectual property rights that relate to our products, services
      or technologies. As the number of competitors in the radiation oncology market
      grows, and as the number of patents issued in this area grows, the possibility
      of a patent infringement claim against us going forward increases. We could
      incur substantial costs and diversion of management resources if we have to
      assert our patent rights against others. An unfavorable outcome to any
      litigation could harm us. In addition, we may not be able to detect infringement
      or may lose competitive position in the market before we do so.




To
      address patent infringement or other intellectual property claims, we may have
      to enter into license agreements and technology cross-licenses or agree to
      pay
      royalties at a substantial cost to us. We may be unable to obtain necessary
      licenses. A valid claim against us and our failure to obtain a license for
      the
      technology at issue could prevent us from selling our products and materially
      adversely affect our business, financial results and future prospects.




**If
      we fail to protect our intellectual property rights or if our intellectual
      property rights do not adequately cover the technologies we employ, or if such
      rights are declared to be invalid, other companies may take advantage of our
      technology ideas and more effectively compete directly against us, or we might
      be forced to discontinue selling certain products.**




Our
      success depends in part on our ability to obtain and enforce patent protections
      for our products and operate without infringing on the proprietary rights of
      third parties. We rely on U.S. and foreign patents to protect our intellectual
      property. We also rely significantly on trade secrets and know-how that we
      seek
      to protect. We attempt to protect our intellectual property rights by filing
      patent applications for new features and products we develop. We enter into
      confidentiality or license agreements with our employees, consultants,
      independent contractors and corporate partners, and we seek to control access
      to
      our intellectual property and the distribution of our products, documentation
      and other proprietary information. We plan to continue these methods to protect
      our intellectual property and our products. These measures may afford only
      limited protection. In addition, the laws of some foreign countries may not
      protect our intellectual property rights to the same extent as do the laws
      of
      the United States.




If
      a
      competitor infringes upon our patent or other intellectual property rights,
      enforcing those rights could be difficult, expensive and time-consuming, making
      the outcome uncertain. Competitors could also bring actions or counterclaims
      attempting to invalidate our patents. Even if we are successful, litigation
      to
      enforce our intellectual property rights or to defend our patents against
      challenge could be costly and could divert our management's attention.




In
      1998
      (prior to our acquisition of NOMOS Corporation), NOMOS became involved in a
      lawsuit, which NOMOS initiated, involving a NOMOS patent relating to the
      ultrasound localization techniques that is used in BAT. In January 2003,
      the district court entered judgment against NOMOS on its infringement claims.
      NOMOS appealed this judgment to the United States Court of Appeals for the
      Federal Circuit. In February 2004, the circuit court upheld the district court's
      judgment and we filed a petition for rehearing, which was denied on
      March 11, 2004. We cannot predict what the adverse effect the result of
      this litigation will have on our future sales of related products.




-41-




Even
      if
      we are able to effectively enforce our existing proprietary rights to the
      fullest extent permitted by law, this would not protect us from competition.
      We
      do not have any patents on IMRT delivery or planning generally, and we have
      competitors that currently market and sell IMRT planning and delivery products
      including inverse planning systems similar to our CORVUS product. In addition,
      our competitors could design around our patents or develop products that provide
      comparable or superior outcomes without infringing on our patents or other
      proprietary rights. The confidentiality agreements with our employees,
      consultants and other third parties may not be enforceable or may not provide
      meaningful protection for our trade secrets or other proprietary information
      in
      the event of unauthorized use or disclosure.




In
      2006,
      we licensed intellectual property which is currently the subject of litigation
      brought by WorldWide Medical Technologies in U.S. District Court against both
      the Company as well as their former employee, Richard Terwilliger, who is
      currently our Vice-President of New Product Development. This intellectual
      property relates to the Company’s brachytherapy business, specifically, certain
      needle-loading and stranding technologies. While the Company does not believe
      that it has any liability in this matter, and is vigorously defending itself
      in
      the litigation, we cannot predict what effect an adverse result from this
      litigation would have on our future sales of the products at issue.




**We
      use radioactive materials which are subject to stringent regulation and which
      may subject us to liability if accidents occur** .





We
      manufacture and process radioactive materials which are subject to stringent
      regulation. We operate under licenses issued by the California Department of
      Health which are renewable every eight years. We received a renewal of our
      license for our North Hollywood facility in 2000 and we were issued a license
      for our Chatsworth facility in March 1999. California is one of the
      "Agreement States," which are so named because the Nuclear Regulatory
      Commission, or NRC, has granted such states regulatory authority over
      radioactive materials, provided such states have regulatory standards meeting
      or
      exceeding the standards imposed by the NRC. Most users of our products must
      obtain licenses issued by the state in which they reside (if they are Agreement
      States) or the NRC. Use licenses are also required by some of the foreign
      jurisdictions in which we may seek to market our products.





Although
      we believe that our safety procedures for handling and disposing of these
      radioactive materials comply with the standards prescribed by state and federal
      regulations, the risk of accidental contamination or injury from these materials
      cannot be completely eliminated. In the event of such an accident, we could
      be
      held liable for any damages that result. We believe we carry reasonably adequate
      insurance to cover us in the event of any damages resulting from the use of
      hazardous materials.




**Healthcare
      reforms, changes in health-care policies and unfavorable changes to third-party
      reimbursements for use of our products, could cause declines in the revenues
      of
      our products.**




Hospitals
      and freestanding clinics may be less likely to purchase our products if they
      cannot be assured of receiving favorable reimbursement for treatments using
      our
      products from third-party payors, such as Medicare, Medicaid and private health
      insurance plans. Generally speaking, Medicare pays hospitals, freestanding
      clinics and physicians a fixed amount for services using our products,
      regardless of the costs incurred by those providers in furnishing the services.
      Such providers may perceive the set reimbursement amounts as inadequate to
      compensate for the costs incurred and thus may be reluctant to furnish the
      services for which our products are designed. Moreover, third-party payors
      are
      increasingly challenging the pricing of medical procedures or limiting or
      prohibiting reimbursement for some services or devices, and we cannot be sure
      that they will reimburse our customers at levels sufficient to enable us to
      achieve or maintain sales and price levels for our products. There is no uniform
      policy on reimbursement among third-party payors, and we can provide no
      assurance that procedures using our products will qualify for reimbursement
      from
      third-party payors or that reimbursement rates will not be reduced or
      eliminated. For example, we have previously been informed that some private
      third-party payors regard IMRT as investigational or experimental and do not
      provide reimbursement for these services at this time. A reduction in or
      elimination of third-party payor reimbursement for treatments using our products
      would likely have a material adverse effect on our revenues.




-42-




Furthermore,
      any federal and state efforts to reform government and private healthcare
      insurance programs could significantly affect the purchase of healthcare
      services and products in general and demand for our products in particular.
      We
      are unable to predict whether potential reforms will be enacted, whether other
      healthcare legislation or regulation affecting the business may be proposed
      or
      enacted in the future or what effect any such legislation or regulation would
      have on our business, financial condition or results of operations.




The
      federal Medicare program currently reimburses hospitals and freestanding clinics
      for both IMRT/IGRT and brachytherapy treatments. Medicare reimbursement amounts
      typically are reviewed and adjusted at least annually. Medicare reimbursement
      policies are reviewed and revised on an ad hoc basis. Adjustments could be
      made
      to these reimbursement policies or amounts, which could result in reduced or
      no
      reimbursement for IMRT/IGRT and brachytherapy services. Changes in Medicare
      reimbursement policies or amounts affecting hospitals and freestanding clinics
      could negatively affect market demand for our products.




With
      respect to brachytherapy in particular, Medicare reimbursement amounts for
      seeding are currently significantly less than for radical prostatectomy, or
      RP.
      Although seeding generally requires less physician time than RP, lower
      reimbursement amounts, when combined with physician familiarity with RP, may
      create disincentives for urologists to perform seeding.




Private
      third-party payors often adopt Medicare reimbursement policies and payment
      amounts. As such, Medicare reimbursement policy and payment amount changes
      concerning our products also could be extended to private third-party payor
      reimbursement policies and amounts and could affect demand for our products
      in
      those markets as well.




Acceptance
      of our products in foreign markets could be affected by the availability of
      adequate reimbursement or funding, as the case may be, within prevailing
      healthcare payment systems. Reimbursement, funding and healthcare payment
      systems vary significantly by country and include both government-sponsored
      healthcare and private insurance. We can provide no assurance that third-party
      reimbursement will be made available with respect to treatments using our
      products under any foreign reimbursement system.




Problems
      with any of these reimbursement systems that adversely affect demand for our
      products could cause our revenues from our products to decline and our business
      to suffer.




Also,
      we,
      our distributors and healthcare providers performing radiation therapy
      procedures are subject to state and federal fraud and abuse laws prohibiting
      kickbacks and, in the case of physicians, patient self-referrals. We may be
      subjected to civil and criminal penalties if we or our agents violate any of
      these prohibitions.





**We
      are subject to extensive government regulation applicable to the manufacture
      and
      distribution of our products. Complying with the Food And Drug Administration
      and other domestic and foreign regulatory bodies is an expensive and
      time-consuming process, whose outcome can be difficult to predict. If we fail
      or
      are delayed in obtaining regulatory approvals or fail to comply with applicable
      regulations, we may be unable to market and distribute our products or may
      be
      subject to civil or criminal penalties.**




-43-




We
      and
      some of our suppliers and distributors are subject to extensive and rigorous
      government regulation of the manufacture and distribution of our products,
      both
      in the United States and in foreign countries. Compliance with these laws and
      regulations is expensive and time-consuming, and changes to or failure to comply
      with these laws and regulations, or adoption of new laws and regulations, could
      adversely affect our business.





In
      the
      United States, as a manufacturer and seller of medical devices and devices
      utilizing radioactive by-product material, we and some of our suppliers and
      distributors are subject to extensive regulation by federal governmental
      authorities, such as the United States Food and Drug Administration, or FDA,
      and
      state and local regulatory agencies, such as the State of California, State
      of
      Pennsylvania and the State of Washington **** to
      ensure
      such devices are safe and effective. Such regulations, which include the U.S.
      Food, Drug and Cosmetic Act, or the FDC Act, and regulations promulgated by
      the
      FDA, govern the design, development, testing, manufacturing, packaging,
      labeling, distribution, import/export, possession, marketing, disposal, clinical
      investigations involving humans, sale and marketing of medical devices,
      post-market surveillance, repairs, replacements, recalls and other matters
      relating to medical devices, radiation producing devices and devices utilizing
      radioactive by-product material. State regulations are extensive and vary from
      state to state. Our brachytherapy seeds and IMRT/IGRT products constitute
      medical devices subject to these regulations. Future products in any of our
      business segments may constitute medical devices and be subject to regulation
      as
      such. These laws require that manufacturers adhere to certain standards designed
      to ensure that the medical devices are safe and effective. Under the FDC Act,
      each medical device manufacturer must comply with requirements applicable to
      manufacturing practices.




In
      the
      United States, medical devices are classified into three different categories,
      over which the FDA applies increasing levels of regulation: Class I,
      Class II, and Class III. The FDA has classified all of our IMRT/IGRT
      products to date as Class II devices. Our brachytherapy products have been
      classified as Class I devices. Before a new device can be introduced into the
      United States market, the manufacturer must obtain FDA clearance or approval
      through either a 510(k) premarket notification or a premarket approval, unless
      the product is otherwise exempt from the requirements. Class I devices are
      statutorily exempt from the 510(k) process, unless the device is intended for
      a
      use which is of substantial importance in preventing impairment of human health
      or it presents a potential unreasonable risk of illness or injury.




A
      510(k)
      premarket notification clearance will typically be granted for a device that
      is
      substantially equivalent to a legally marketed Class I or Class II
      medical device or a Class III medical device for which the FDA has not yet
      required submission of a premarket approval. A 510(k) premarket notification
      must contain information supporting the claim of substantial equivalence, which
      may include laboratory results or the results of clinical studies. Following
      submission of a 510(k) premarket notification, a company may not market the
      device for clinical use until the FDA finds the product is substantially
      equivalent for a specific or general intended use. FDA clearance generally
      takes
      from four to twelve months, but it may take longer, and there is no assurance
      that the FDA will ultimately grant a clearance. The FDA may determine that
      a
      device is not substantially equivalent and require submission and approval
      of a
      premarket approval or require further information before it is able to make
      a
      determination regarding substantial equivalence.




Most
      of
      the products that we are currently marketing have received clearances from
      the
      FDA through the 510(k) premarket notification process. For any devices already
      cleared through the 510(k) process, modifications or enhancements that could
      significantly affect safety or effectiveness, or constitute a major change
      in
      intended use require a new 510(k) submission and a separate FDA determination
      of
      substantial equivalence. We have made minor modifications to our products and,
      using the guidelines established by the FDA, have determined that these
      modifications do not require us to file new 510(k) submissions. If the FDA
      disagrees with our determinations, we may not be able to sell one or more of
      our
      products until the FDA has cleared new 510(k) submissions for these
      modifications, and there is no assurance that the FDA will ultimately grant
      a
      clearance. In addition, the FDA may determine that future products require
      the
      more costly, lengthy and uncertain premarket approval process under
      Section 515 of the FDC. The approval process under Section 515
      generally takes from one to three years, but in many cases can take even longer,
      and there can be no assurance that any approval will be granted on a timely
      basis, if at all. Under the premarket approval process, an applicant must
      generally conduct at least one clinical investigation and submit extensive
      supporting data and clinical information establishing the safety and
      effectiveness of the device, as well as extensive manufacturing information.
      Clinical investigations themselves are typically lengthy and expensive, closely
      regulated and frequently require prior FDA clearance. Even if clinical
      investigations are conducted, there is no assurance that they will support
      the
      claims for the product. If the FDA requires us to submit a new premarket
      notification under Section 510(k) for modifications to our existing
      products, or if the FDA requires us to go through the lengthier, more rigorous
      Section 515 premarket approval process, our product introductions or
      modifications could be delayed or cancelled, which could cause our revenues
      to
      be below expectations.




-44-




In
      addition to FDA-required market clearances and approvals, our manufacturing
      operations are required to comply with the FDA's Quality System Regulation,
      or
      QSR, which addresses the quality program requirements, such as a company's
      management responsibility for the company's quality systems, and good
      manufacturing practices, product design, controls, methods, facilities and
      quality assurance controls used in manufacturing, assembly, packing, storing
      and
      installing medical devices. Compliance with the QSR is necessary to receive
      FDA
      clearance or approval to market new products and is necessary for us to be
      able
      to continue to market cleared or approved product offerings. There
      can
      be no assurance that we will not incur significant costs to comply with these
      regulations in the future or that the regulations will not have a material
      adverse effect on our business, financial condition and results of operations.
      Our compliance and the compliance by some of our suppliers with applicable
      regulatory requirements is and will continue to be monitored through periodic
      inspections by the FDA. The
      FDA
      makes announced and unannounced inspections to determine compliance with the
      QSR's and may issue us 483 reports listing instances where we have failed to
      comply with applicable regulations and/or procedures or Warning Letters which,
      if not adequately responded to, could lead to enforcement actions against us,
      including fines, the total shutdown of our production facilities and criminal
      prosecution.




If
      we or
      any of our suppliers fail to comply with FDA requirements, the FDA can institute
      a wide variety of enforcement actions, ranging from a public warning letter
      to
      more severe sanctions such as:




•
            fines,
                injunctions and civil penalties;


•
            the
                recall or seizure of our products;


•
            the
                imposition of operating restrictions, partial suspension or total
                shutdown
                of production;


•
            the
                refusal of our requests for 510(k) clearance or premarket approval
                of new
                products;


•
            the
                withdrawal of 510(k) clearance or premarket approvals already granted;
                and


•
            criminal
                prosecution.




Similar
      consequences could arise from our failure, or the failure by any of our
      suppliers, to comply with applicable foreign laws and regulations. Foreign
      regulatory requirements vary by country. In general, our products are regulated
      outside the United States as medical devices by foreign governmental agencies
      similar to the FDA. However, the time and cost required to obtain regulatory
      approvals from foreign countries could be longer than that required for FDA
      clearance and the requirements for licensing a product in another country may
      differ significantly from the FDA requirements. We rely, in part, on our foreign
      distributors to assist us in complying with foreign regulatory requirements.
      We
      may not be able to obtain these approvals without incurring significant expenses
      or at all, and the failure to obtain these approvals would prevent us from
      selling our products in the applicable countries. This could limit our sales
      and
      growth.




**Doctors
      and hospitals may not adopt our products and technologies at levels sufficient
      to sustain our business or to achieve our desired growth rate.**




Intensity
      modulated radiation therapy and image-guided radiation therapy are both
      relatively new technologies and, to date, we have attained only limited
      penetration of the total potential worldwide market. Our future growth and
      success depends upon creating broad awareness and acceptance of IMRT/IGRT
      generally and our products in particular by doctors, hospitals and freestanding
      clinics, as well as patients. This will require substantial marketing and
      educational efforts, which will be costly and may not be successful. The target
      customers for our IMRT/IGRT products may not adopt these technologies or may
      adopt them at a rate that is slower than desired. In addition, as described
      above, potential customers who decide to utilize IMRT/IGRT may choose to
      purchase competitors' products. Important factors that will affect our ability
      to attain broad market acceptance of our IMRT/IGRT products include:




-45-




•
            doctor
                and patient awareness and acceptance of IMRT/IGRT and our products;


•
            the
                real or perceived effectiveness and safety of IMRT/IGRT and our products;


•
            the
                relationship between the cost of our products and the real or perceived
                medical benefits of IMRT/IGRT and our products;


•
            the
                relationship between the cost of our products and the financial benefits
                to our customers of using our products, which will be greatly affected
                by
                the coverage of, and reimbursement for, IMRT/IGRT treatment and ultrasound
                guidance by governmental and private third-party payors; and


•
            market
                perception of our ability to continue to grow our business and develop
                enhanced IMRT/IGRT products.




Failure
      of our products to gain broad market acceptance could cause our revenues to
      decline and our business to suffer.




**Our
      future growth depends, in part, on our ability to penetrate foreign markets,
      particularly in Asia and Europe. However, we may encounter difficulties in
      gaining acceptance of our products in foreign markets, where we have limited
      experience marketing, servicing and distributing our products, and where we
      will
      be subject to additional regulatory burdens and other
      risks.**




Our
      future profitability will depend in part on our ability to establish, grow
      and
      ultimately maintain our product sales in foreign markets, particularly in Asia
      and Europe. However, we have limited experience in marketing, servicing and
      distributing our products in other countries. In 2005, less than 5% of our
      product revenues and less than 5% of our total revenues were derived from sales
      to customers outside the United States and Canada. Our foreign operations
      subject us to additional risks and uncertainties, including:




•
            our
                customers' ability to obtain reimbursement for procedures using our
                products in foreign markets;


•
            the
                burden of complying with complex and changing foreign regulatory
                requirements;


•
            language
                barriers and other difficulties in providing long-range customer
                support
                and service;


•
            longer
                accounts receivable collection times;


•
            significant
                currency fluctuations, which could cause our distributors to reduce
                the
                number of products they purchase from us because the cost of our
                products
                to them could fluctuate relative to the price they can charge their
                customers;


•
            reduced
                protection of intellectual property rights in some foreign countries;
                and


•
            the
                interpretation of contractual provisions governed by foreign laws
                in the
                event of a contract dispute.




Our
      foreign sales of our products could also be adversely affected by export license
      requirements, the imposition of governmental controls, political and economic
      instability, trade restrictions, changes in tariffs and difficulties in staffing
      and managing foreign operations. In addition, we are subject to the Foreign
      Corrupt Practices Act, any violation of which could create a substantial
      liability for us and also cause a loss of reputation in the market.




**As
      part of our business strategy, we intend to pursue transactions that may cause
      us to experience significant charges to earnings that may adversely affect
      our
      stock price and financial condition** .




-46-




We
      regularly review potential transactions related to technologies, product
      candidates or product rights and businesses complementary to our business.
      Such
      transactions could include mergers, acquisitions, strategic alliances, licensing
      agreements or co-promotion agreements. Our acquisition of Theseus Imaging
      Corporation in October 2000 and the acquisition of NOMOS, in May 2004, are
      examples of such transactions. In the future, if we have sufficient available
      capital, we may choose to enter into such transactions. We may not be able
      to
      successfully integrate newly acquired organizations, products or technologies
      into our business and the process could be expensive and time consuming and
      may
      strain our resources. Depending upon the nature of any transaction, we may
      experience a charge to earnings which could be material.





**Operating
      results for a particular period may fluctuate and are difficult to
      predict.**





The
      results of operations for any fiscal quarter or fiscal year are not necessarily
      indicative of results to be expected in future periods. Our operating results
      have in the past been, and will continue to be, subject to quarterly and annual
      fluctuations as a result of a number of factors. As a consequence, operating
      results for a particular future period are difficult to predict. Such factors
      include the following:





·
            Our
                net sales may grow at a slower rate than experienced in previous
                periods
                and, in particular periods, may
                decline;


·
            Our
                brachytherapy product lines may experience some variability in revenue
                due
                to seasonality. This is primarily due to three major holidays occurring
                in
                our first fiscal quarter and the apparent reduction in the number
                of
                procedures performed during summer months, which could affect our
                third
                fiscal quarter results;


·
            Estimates
                with respect to the useful life and ultimate recoverability of our
                carrying basis of assets, including goodwill and purchased intangible
                assets, could change as a result of such assessments and
                decisions;


·
            As
                a result of our growth in past periods, our fixed costs have increased.
                With increased levels of spending and the impact of long-term commitments,
                we may not be able to quickly reduce these fixed expenses in response
                to
                short-term business changes;


·
            Acquisitions
                that result in in-process research and development expenses may be
                charged
                fully in an individual quarter;


·
            Sales
                of our IMRT/IGRT products are typically heavier in the final month
                of a
                fiscal quarter, leading to a disproportionately high use of cash
                in the
                first two months of a quarter;


·
            Changes
                or anticipated change in third-party reimbursement amounts or policies
                applicable to treatments using our
                products;


·
            Timing
                of the announcement, introduction and delivery of new products or
                product
                enhancements by us and by our competitors;


·
            The
                possibility that unexpected levels of cancellations of orders or
                backlog
                may affect certain assumptions upon which we base our forecasts and
                predictions of future performance;


·
            Changes
                in the general economic conditions in the regions in which we do
                business;


·
            Unfavorable
                outcome of any litigation; and


·
            Accounting
                adjustments such as those relating to reserves for product recalls
                and
                changes in interpretation of accounting
                pronouncements.





**Being
      a public company significantly increases our administrative
      costs.**





The
      Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the
      SEC
      and listing requirements subsequently adopted by NASDAQ in response to
      Sarbanes-Oxley, have required changes in corporate governance practices,
      internal control policies and audit committee practices of public companies.
      These rules, regulations, and requirements have significantly increased our
      legal, financial, compliance and administrative costs, and have made certain
      other activities more time consuming and costly, as well as requiring
      substantial time and attention of our senior management. The Company expects
      its
      continued compliance with these and future rules and regulations to continue
      to
      require significant resources. These new rules and regulations also may make
      it
      more difficult and more expensive for us to obtain director and officer
      liability insurance in the future, and could make it more difficult for us
      to
      attract and retain qualified members for our Board of Directors, particularly
      to
      serve on our audit committee.





-47-




**Our
      publicly-filed SEC reports are reviewed by the SEC from time to time and any
      significant changes required as a result of any such review may result in
      material liability to us and have a material adverse impact on the trading
      price
      of our common stock.**




The
      reports of publicly-traded companies are subject to review by the SEC from
      time
      to time for the purpose of assisting companies in complying with applicable
      disclosure requirements and to enhance the overall effectiveness of companies
      public filings, and comprehensive reviews of such reports are now required
      at
      least every three years under the Sarbanes-Oxley Act of 2002. While we believe
      that our previously filed SEC reports comply, and we intend that all future
      reports will comply in all material respects with the published rules and
      regulations of the SEC, we could be required to modify or reformulate
      information contained in prior filings as a result of an SEC review.  Any
      modification or reformulation of information contained in such reports could
      be
      significant and result in material liability to us and have a material adverse
      impact on the trading price of our common stock.





**Future
      financing transactions may have a dilutive or other negative effect on our
      existing shareholders.**





The
      Company recently completed a private placement of shares of its common stock
      that also includes a significant number of warrants. This financing resulted
      in
      significant dilution of the Company’s current shareholders. In the future, the
      Company may issue additional equity, debt or convertible securities to raise
      capital. If the Company does so, the percentage ownership of the Company held
      by
      existing shareholders would be further reduced, and existing shareholders may
      experience significant dilution. In addition, new investors in the Company
      may
      demand rights, preferences or privileges that differ from, or are senior to,
      those of our existing shareholders, such as warrants in addition to the
      securities purchased and other protections against future dilutive transactions.
      In addition, any debt securities that we may issue and sell in the future could
      result in increased debt on our balance sheet, additional interest and financing
      expense and/or decreased operating income.





**We
      had been notified that we did not satisfy all of the continued listing criteria
      established by The Nasdaq Global Market. We now believe that we are in
      compliance with the continued listing criteria established by the Nasdaq Global
      Market. If in the future Nasdaq determines that we are not in compliance, the
      liquidity of our common stock could be adversely affected if we are delisted
      from The Nasdaq Global Market.**




On
      March
      16, 2006, we received a Nasdaq Staff Deficiency Letter dated March 14, 2006
      indicating that, based on our Form 10-Q for the period ended January 31, 2006,
      Nasdaq had determined that we are not in compliance with the minimum $10 million
      stockholders’ equity requirement for continued listing on The Nasdaq Global
      Market set forth in Marketplace Rule 4450(a)(3). On April 28, 2006, we received
      a notice from Nasdaq stating that our securities will be delisted from The
      Nasdaq Global Market at the opening of business on May 9, 2006, unless we
      requested a hearing in accordance with the Marketplace Rule 4800 Series. On
      May
      3, 2006, we requested a hearing with The Nasdaq Listing Qualifications Panel
      to
      appeal the Staff’s determination to delist our securities from The Nasdaq Global
      Market. The hearing before the Panel to present our plan of compliance was
      held
      on June 15, 2006. On June 28, 2006, we received notice from The Nasdaq Stock
      Market granting our request for continued listing on the Nasdaq Global Market.
      Continued listing is subject to our filing our SEC Form 10-Q for the quarter
      ending July 31, 2006 evidencing stockholders’ equity above $10 million and
      otherwise continuing to comply with all other continued listing requirements
      of
      The Nasdaq Global Market. Based upon the recent closing of the $24 million
      private placement of the Company’s common stock, we believe our SEC Form 10-Q
      for the quarter ending July 31, 2006 will satisfy the stockholders’ equity
      requirement. Upon review of our Form 10-Q for the quarter ending July 31, 2006,
      Nasdaq will determine whether or not to delist our securities. If such delisting
      occurs, the market price and market liquidity of our common stock may be
      adversely affected.




-48-




Alternatively,
      if faced with such delisting, we may submit an application to transfer the
      listing of our common stock to The Nasdaq Capital Market. Among other
      requirements, The Nasdaq Capital Market has a minimum $2.5 million stockholders’
equity requirement for continued listing.




Alternatively,
      if our common stock is delisted by Nasdaq, our common stock may be eligible
      to
      trade on the American Stock Exchange, the OTC Bulletin Board maintained by
      Nasdaq, another over-the-counter quotation system, or on the pink sheets where
      an investor may find it more difficult to dispose of or obtain accurate
      quotations as to the market value of our common stock, although there can be
      no
      assurance that our common stock will be eligible for trading on any alternative
      exchanges or markets. In addition, we would be subject to Rule 15c2-11
      promulgated by the SEC. If we fail to meet criteria set forth in the rule (for
      example, by failing to file periodic reports as required by the Exchange Act),
      various practice requirements are imposed on broker-dealers who sell securities
      governed by the rule to persons other than established customers and accredited
      investors. For these types of transactions, the broker-dealer must make a
      special suitability determination for the purchaser and have received the
      purchaser's written consent to the transactions prior to sale. Consequently,
      such rule may deter broker-dealers from recommending or selling our common
      stock, which may further affect the liquidity and price of our common
      stock.




Delisting
      from Nasdaq would make trading our common stock more difficult for investors,
      potentially leading to further declines in our share price. It would also make
      it more difficult for us to raise additional capital.




**Item
      4. Submission of Matters to a Vote of Security Holders**




On
      May 3,
      2006 we held our 2006 Annual Meeting of Stockholders. Proposals to be voted
      upon
      were the election of directors and the approval of the North American
      Scientific, Inc. 2006 Stock Plan.





The
      following persons were elected as directors to hold office until the 2007 Annual
      Meeting of Stockholders: L. Michael Cutrer, John A. Friede, Dr. Jonathan P.
      Gertler, John M. Sabin, Richard A. Sandberg, Dr. Gary N. Wilner, and Nancy
      J.
      Wysenski. There were no broker non-votes. The number of shares cast for,
      withheld and abstained with respect to each of the nominees were as
      follows:





Nominee
            
            For
            
            Withheld
            
            AbstainedL.
                Michael Cutrer
            
            13,180,706
            
            —
            
            709,468John
                A. Friede
            
            13,348,835
            
            —
            
            541,339Dr.
                Jonathan P. Gertler
            
            11,891,529
            
            —
            
            1,998,645John
                M. Sabin
            
            13,326,545
            
            —
            
            563,629Richard
                A. Sandberg
            
            12,050,022
            
            —
            
            1,840,152Dr.
                Gary N. Wilner
            
            13,186,542
            
            —
            
            703,632Nancy
                J. Wysenski
            
            12,058,822
            
            —
            
            1,831,352




The
      North
      American Scientific, Inc. 2006 Stock Plan was approved. The number of shares
      cast for, withheld, abstained and broker non-votes with respect to this item
      were as follows:




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Description
            
            For
            
            Withheld
            
            Abstained
            
            Broker
                Non-VotesApproval
                of the 2006 Stock Plan
            
            5,104,736
            
            2,133,189
            
            20,449
            
            6,631,800




**Item
      6.**  **Exhibits**





(a)
            Exhibits.




Exhibits
                  No.
              
              Title10.1
              
              North
                  American Scientific, Inc. 2006 Stock Plan. (1)10.2
              
              Securities
                  Purchase Agreement dated June 6, 2006 between the Company and the
                  investors. (2)10.3
              
              Form
                  of Warrant Agreement between the Company and Three Arch Partners.
                  (2)10.4
              
              Form
                  of Warrant Agreement between the Company and certain other investors.
                  (2)10.5
              
              Second
                  Amendment to Rights Agreement, dated June 5, 2006 by and between
                  the
                  Company and U.S. Stock Transfer Corporation. (2)31.1
              
              Certification
                  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
                  Act of 200231.2
              
              Certification
                  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
                  Act of 200232.1
              
              Certification
                  of Chief Executive Officer and Chief Financial Officer Pursuant
                  to Section
                  906 of the Sarbanes-Oxley Act of
                  2002







(1)
            Incorporated
                by reference to Appendix A to the Company’s Definitive Proxy Statement
                filed on April 5, 2006.


(2)
            Incorporated
                by reference to the Company’s Current Report on Form 8-K filed on June 7,
                2006.


-50-


**SIGNATURES**




Pursuant
      to the requirements of the Securities Exchange Act of 1934, the Registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.


NORTH
              AMERICAN
              SCIENTIFIC, INC.September
              11,
              2006
            By:
            /s/ L.
              Michael CutrerName:L.
                Michael CutrerTitle:President
                and
                Chief
                  Executive Officer
                (Principal Executive Officer) September
              11,
              2006
            By:
            /s/ James
              W.
              KlinglerName:James
              W. KlinglerTitle:Senior
                Vice President and
              Chief Financial Officer
              (Principal Financial Officer)




-51-


**EXHIBIT
      INDEX**




Exhibits
                No.
            
            Title10.1
            
            North
                American Scientific, Inc. 2006 Stock Plan, incorporated by reference
                to
                Appendix A to the Company’s Definitive Proxy Statement filed on April 5,
                2006.10.2
            
            Securities
                Purchase Agreement dated June 6, 2006 between the Company and the
                investors, incorporated by reference to the Company’s Current Report on
                Form 8-K filed on June 7, 2006.10.3
            
            Form
                of Warrant Agreement between the Company and Three Arch Partners,
                incorporated by reference to the Company’s Current Report on Form 8-K
                filed on June 7, 2006.10.4
            
            Form
                of Warrant Agreement between the Company and certain other investors,
                incorporated by reference to the Company’s Current Report on Form 8-K
                filed on June 7, 2006.10.5
            
            Second
                Amendment to Rights Agreement, dated June 5, 2006 by and between
                the
                Company and U.S. Stock Transfer Corporation, incorporated by reference
                to
                the Company’s Current Report on Form 8-K filed on June 7,
                2006.31.1
            
            Certification
                of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200231.2
            
            Certification
                of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
                Act of 200232.1
            
            Certification
                of Chief Executive Officer and Chief Financial Officer Pursuant to
                Section
                906 of the Sarbanes-Oxley Act of
                2002




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