#### ** **

#### **UNITEDSTATES**

#### **SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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

 

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

 

**For the quarterly period ended April 30, 2005**

 

**or**

 

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

 

**Commission File Number 0-26670**

 

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#### **NORTH AMERICAN SCIENTIFIC, INC.**

(Exact name of registrantas 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)        |

 

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Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

ýYes    o No

 

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

 

ý Yes    oNo

 

The number of shares of Registrant’s Common Stock, $.01 par value,outstanding as of May 31, 2005 was 16,394,252 shares.

 

** **

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** **

**NORTH AMERICANSCIENTIFIC, INC.**

** **

**Index**

 
| **Part I – Financial Information** | ** **                                                                                                  |
|----------------------------------------------|-------------------------------------------------------------------------------------------------------------|
| ** **                                   | ** **                                                                                                  | ** ** |
| **Item 1.**                                  | **Financial Statements**                                                                                    | ** ** |
| ** **                                   | ** **                                                                                                  | ** ** |
| ** **                                   | **Consolidated Balance Sheets  as of April 30, 2005 and October 31, 2004**                        | ** ** |
| ** **                                   | **Consolidated  Statements of Operations for the three and six months ended April 30,  2005 and 2004** | ** ** |
| ** **                                   | **Consolidated  Statements of Cash Flows for the six months ended April 30, 2005 and  2004**           | ** ** |
| ** **                                   | **Condensed  Notes to the Consolidated Financial Statements**                                               | ** ** |
| ** **                                   | ** **                                                                                                  | ** ** |
| **Item 2.**                                  | **Management’s Discussion and  Analysis of Financial Condition and Results of Operations**             | ** ** |
| ** **                                   | ** **                                                                                                  | ** ** |
| **Item 3.**                                  | **Quantitative and Qualitative  Disclosures about Market Risk**                                             | ** ** |
| ** **                                   | ** **                                                                                                  | ** ** |
| **Item 4.**                                  | **Controls and Procedures**                                                                                 | ** ** |
| ** **                                   | ** **                                                                                                  | ** ** |
| **Part II – Other Information**    | ** **                                                                                                  |
| ** **                                   | ** **                                                                                                  | ** ** |
| **Item 6.**                                  | **Exhibits**                                                                                                | ** ** |
| ** **                                   | ** **                                                                                                  | ** ** |
| **Signatures**                               | ** **                                                                                                  |
|                                              |                                                                                                             |  |  |

 

2

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**PART I****– FINANCIAL INFORMATION**

 

###### **Item1**.  Financial Statements

###### ** **

**NORTHAMERICAN SCIENTIFIC, INC.**

** **

**Consolidated Balance Sheets**

** **
| ** **                                                                                                                                                                                                              | ** ** | **April  30,  2005** | ** ** | **October 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                                              | ** ** | **(Unaudited)**           | ** ** | ** **                 | ** ** |
| **Assets**                                                                                                                                                                                                              |       |                      |       |                       |       |
|                                                                                                                                                                                                                    |       |                      |       |                       |       |
| Current assets                                                                                                                                                                                                          |       |                      |       |                       |       |
| Cash and cash  equivalents                                                                                                                                                                                              |       | $                         | 268,000    |                       | $          | 2,334,000 |   |
| Marketable  securities                                                                                                                                                                                                  |       | 6,134,000                 |       | 10,046,000                 |       |
| Accounts  receivable                                                                                                                                                                                                    |       | 7,228,000                 |       | 7,132,000                  |       |
| Inventories                                                                                                                                                                                                             |       | 4,086,000                 |       | 4,871,000                  |       |
| Prepaid expenses  and other current assets                                                                                                                                                                              |       | 1,312,000                 |       | 1,061,000                  |       |
| Total current assets                                                                                                                                                                                               |       | 19,028,000                |       | 25,444,000                 |       |
| Non-current marketable securities                                                                                                                                                                                  |       | —                    |       | 2,600,000                  |       |
| Equipment and  leasehold improvements                                                                                                                                                                                   |       | 3,871,000                 |       | 4,127,000                  |       |
| Goodwill                                                                                                                                                                                                                |       | 18,732,000                |       | 18,732,000                 |       |
| Intangible  assets                                                                                                                                                                                                      |       | 28,354,000                |       | 29,504,000                 |       |
| Other assets                                                                                                                                                                                                            |       | 121,000                   |       | 132,000                    |       |
| Total assets                                                                                                                                                                                                            |       | $                         | 70,106,000 |                       | $          | 80,539,000 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                           |       |                      |       |                       |       |
|                                                                                                                                                                                                                    |       |                      |       |                       |       |
| Current  liabilities                                                                                                                                                                                                    |       |                      |       |                       |       |
| Accounts payable                                                                                                                                                                                                        |       | $                         | 1,284,000  |                       | $          | 2,061,000 |   |
| Accrued expenses                                                                                                                                                                                                        |       | 5,513,000                 |       | 6,808,000                  |       |
| Deferred revenue                                                                                                                                                                                                        |       | 5,295,000                 |       | 6,293,000                  |       |
| Total current  liabilities                                                                                                                                                                                              |       | 12,092,000                |       | 15,162,000                 |       |
|                                                                                                                                                                                                                    |       |                      |       |                       |       |
| Commitments and  contingencies                                                                                                                                                                                          |       |                      |       |                       |       |
|                                                                                                                                                                                                                    |       |                      |       |                       |       |
| Stockholders’  Equity                                                                                                                                                                                              |       |                      |       |                       |       |
| Preferred stock,  $0.01 par value, 2,000,000 shares authorized; no shares issued                                                                                                                                        |       | —                    |       | —                     |       |
| Common stock,  $0.01 par value, 40,000,000 shares authorized, 16,441,131 and 16,308,487  shares issued; 16,333,105 and 16,200,461 shares outstanding as of  April 30, 2005 and October 31, 2004, respectively |       | 167,000                   |       | 163,000                    |       |
| Additional  paid-in capital                                                                                                                                                                                             |       | 120,431,000               |       | 120,220,000                |       |
| Treasury stock,  at cost – 108,026 common shares                                                                                                                                                                   |       | (129,000                  | )          | (129,000                   | )          |
| Accumulated  deficit                                                                                                                                                                                                    |       | (62,455,000               | )          | (54,877,000                | )          |
| Total  stockholders’ equity                                                                                                                                                                                        |       | 58,014,000                |       | 65,377,000                 |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                        |       | $                         | 70,106,000 |                       | $          | 80,539,000 |   |

 

Seecondensed notes to the consolidated financial statements.

 

3

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**NORTH AMERICANSCIENTIFIC, INC.**

** **

**ConsolidatedStatements of Operations**

**(Unaudited)**

** **
| ** **                                     | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                        |       |                                  |       |                                |       |   |   |   |   |
| Product                                        |       | $                                     | 5,843,000  |                                | $          | 3,482,000 |   | $ | 11,216,000 |   | $ | 6,845,000 |   |
| Service                                        |       | 3,298,000                             |       | —                              |       | 6,089,000 |   | — |   |
| Total revenue                                  |       | 9,141,000                             |       | 3,482,000                           |       | 17,305,000 |   | 6,845,000 |   |
| Cost of revenue                                |       |                                  |       |                                |       |   |   |   |   |
| Product                                        |       | 4,603,000                             |       | 1,933,000                           |       | 8,828,000 |   | 3,838,000 |   |
| Service                                        |       | 880,000                               |       | —                              |       | 1,890,000 |   | — |   |
| Total cost of  revenue                         |       | 5,483,000                             |       | 1,933,000                           |       | 10,718,000 |   | 3,838,000 |   |
| Gross profit                                   |       | 3,658,000                             |       | 1,549,000                           |       | 6,587,000 |   | 3,007,000 |   |
| Operating  expenses                            |       |                                  |       |                                |       |   |   |   |   |
| Selling expenses                               |       | 2,164,000                             |       | 853,000                             |       | 4,303,000 |   | 1,632,000 |   |
| General and  administrative expenses           |       | 3,278,000                             |       | 2,005,000                           |       | 5,580,000 |   | 5,119,000 |   |
| Research and  development                      |       | 1,624,000                             |       | 155,000                             |       | 3,256,000 |   | 321,000 |   |
| Amortization of  intangible assets             |       | 575,000                               |       | 11,000                              |       | 1,150,000 |   | 22,000 |   |
| Total operating  expenses                      |       | 7,641,000                             |       | 3,024,000                           |       | 14,289,000 |   | 7,094,000 |   |
| Loss from  operations                          |       | (3,983,000                            | )          | (1,475,000                          | )          | (7,702,000 | ) | (4,087,000 | ) |
| Interest and  other income                     |       | 55,000                                |       | 164,000                             |       | 124,000 |   | 375,000 |   |
| Loss before  provision for income taxes        |       | (3,928,000                            | )          | (1,311,000                          | )          | (7,578,000 | ) | (3,712,000 | ) |
| Provision for  income taxes                    |       | —                                |       | —                              |       | — |   | — |   |
| Loss from  continuing operations               |       | (3,928,000                            | )          | (1,311,000                          | )          | (7,578,000 | ) | (3,712,000 | ) |
| Loss from  discontinued operation              |       | —                                |       | (2,599,000                          | )          | — |   | (4,128,000 | ) |
| Net loss                                       |       | $                                     | (3,928,000 | )                                   | $          | (3,910,000 | ) | $ | (7,578,000 | ) | $ | (7,840,000 | ) |
| Basic and  diluted loss per share:             |       |                                  |       |                                |       |   |   |   |   |
| Continuing operations                          |       | (0.24                                 | )          | (0.13                               | )          | (0.47 | ) | (0.36 | ) |
| Discontinued  operation                        |       | —                                |       | (0.25                               | )          | — |   | (0.40 | ) |
| Net loss per  share                            |       | (0.24                                 | )          | (0.38                               | )          | (0.47 | ) | (0.76 | ) |
| Weighted average  number of shares outstanding |       | 16,231,436                            |       | 10,338,011                          |       | 16,287,595 |   | 10,343,740 |   |

 

Seecondensed notes to the consolidated financial statements.

 

4

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**NORTH AMERICANSCIENTIFIC, INC.**

** **

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**

** **
| ** **                                                                   | ** ** | **Six Months Ended April 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                       |       |                                |       |   |   |
| Net loss                                                                     |       | $                                   | (7,578,000 | ) | $ | (7,840,000 | ) |
| Loss from  discontinued operation                                            |       | —                              |       | 4,128,000 |   |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                |       |   |   |
| Depreciation and  amortization                                               |       | 1,713,000                           |       | 413,000 |   |
| Non-cash  stock-based compensation                                           |       | —                              |       | 351,000 |   |
| Provision for  doubtful accounts                                             |       | 254,000                             |       | 20,000 |   |
| Changes in  assets and liabilities, net of discontinued operation:           |       |                                |       |   |   |
| Accounts  receivable                                                         |       | (350,000                            | )          | (158,000 | ) |
| Inventories                                                                  |       | 785,000                             |       | (21,000 | ) |
| Prepaid and  other current assets                                            |       | (427,000                            | )          | (327,000 | ) |
| Accounts payable                                                             |       | (729,000                            | )          | (244,000 | ) |
| Accrued expenses                                                             |       | (766,000                            | )          | (24,000 | ) |
| Income tax  receivable                                                       |       | —                              |       | 496,000 |   |
| Deferred revenue                                                             |       | (998,000                            | )          | — |   |
| Net cash used in  continuing operations                                      |       | (8,096,000                          | )          | (3,206,000 | ) |
| Net cash used in  discontinued operation                                     |       | (497,000                            | )          | (4,640,000 | ) |
| Net cash used in  operating activities                                       |       | (8,593,000                          | )          | (7,846,000 | ) |
| Cash flows from  investing activities:                                       |       |                                |       |   |   |
| Proceeds from  sale of marketable securities                                 |       | 6,512,000                           |       | 15,868,000 |   |
| Purchase of  marketable securities                                           |       | —                              |       | (8,099,000 | ) |
| Capital  expenditures                                                        |       | (200,000                            | )          | (996,000 | ) |
| Other assets                                                                 |       | —                              |       | (967,000 | ) |
| Net cash  provided by investing activities                                   |       | 6,312,000                           |       | 5,806,000 |   |
| Cash flow from  financing activities:                                        |       |                                |       |   |   |
| Proceeds from  exercise of stock options and stock purchase plan             |       | 215,000                             |       | 1,282,000 |   |
| Net cash  provided by finance activities                                     |       | 215,000                             |       | 1,282,000 |   |
| Net decrease in  cash and cash equivalents                                   |       | (2,066,000                          | )          | (758,000 | ) |
|                                                                         |       |                                |       |   |   |
| Cash and cash  equivalents at beginning of period                            |       | 2,334,000                           |       | 1,761,000 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                   | 268,000    |   | $ | 1,003,000 |   |

 

Seecondensed notes to the consolidated financial statements.

 

5

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**NORTH AMERICANSCIENTIFIC, INC.**

** **

**CondensedNotes to Consolidated Financial Statements**

**(Unaudited)**

** **

**NOTE 1 – SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

** **

*Basis ofPresentation*

* *

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

 

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

 

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

 

*Management’s Plans*

* *

The accompanying financial statements have beenprepared on a going concern basis, which contemplates the realization of assetsand liquidation of liabilities in the normal course of business. However, theCompany has continued to incur substantial net losses and used substantialamounts of cash.  As of April 30,2005, the Company has an accumulated deficit of $62.4 million, cash, cashequivalents and marketable securities of $6.4 million and no debt.

 

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

 

6

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*Use of Estimates*

 

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

 

*Accounting forStock-based Compensation*

 

The Company accounts for its stock option awards to employeesand directors using the intrinsic value method of accounting in accordance withAccounting Principles Board (“APB”) Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations.  The Company has provided additional disclosuresrequired by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accountingfor Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock Based Compensation – Transition and Disclosure – an Amendment ofFASB Statement No. 123.”

 

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

 
| ** **                                     | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as  reported                         |       | $                                     | (3,928,000 | )                                   | $          | (3,910,000 | ) | $ | (7,578,000 | ) | $ | (7,840,000 | ) |
| Add: stock-based  compensation recognized      |       | —                                |       | —                              |       | — |   | 351,000 |   |
| Less: total  stock-based compensation (1)      |       | (374,000                              | )          | (995,000                            | )          | (804,000 | ) | (1,599,000 | ) |
| Net loss, as  adjusted                         |       | $                                     | (4,302,000 | )                                   | $          | (4,905,000 | ) | $ | (8,382,000 | ) | $ | (9,088,000 | ) |
| Basic and  diluted loss per share, as reported |       | $                                     | (0.24      | )                                   | $          | (0.38 | ) | $ | (0.47 | ) | $ | (0.76 | ) |
| Basic and  diluted loss per share, as adjusted |       | $                                     | (0.27      | )                                   | $          | (0.47 | ) | $ | (0.51 | ) | $ | (0.88 | ) |

 

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**(1) As determined underthe fair value method.**

** **

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

** **

*RevenueRecognition*

* *

The Company sells products principally for theradiation oncology community, including intensity modulated radiation therapy (“IMRT”)and image guided radiation therapy (“IGRT”) products and services, as well asbrachytherapy seeds used in the treatment of cancer.  Product revenue consists of brachytherapy,non-therapeutic sources, certain IMRT hardware devices and software productsincluding

 

7

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IMRT treatment planningand delivery systems and our IGRT system.  Servicerevenue consists of warranty revenue from product sales and maintenance serviceagreements.

 

Product revenue

 

The Company applies the provisions of SEC StaffAccounting Bulletin (“SAB”) No. 104, “Revenue Recognition” for the sale of non-softwareproducts.  SAB 104 which supersedes SABno. 101, “Revenue Recognition in Financial Statements”, provides guidance onthe recognition, presentation and disclosure of revenue in financialstatements.  SAB No. 104 outlinesthe basic criteria that must be met to recognize revenue and provides guidancefor the disclosure of revenue recognition policies.  In general, the Company recognizes revenuerelated to product sales when (i) persuasive evidence of an arrangementexists, (ii) delivery has occurred, (iii) the fee is fixed ordeterminable, and (iv) collectibility is reasonablyassured.

 

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

 

The Company’s software product revenue is generatedfrom the sale of advanced medical equipment products.  The software element of the Company’sproducts is deemed an essential element of the functionality of the product.  Maintenance and support are provided with theinitial product sale for a twelve month period, and are renewable annually or forlonger periods, at the customer’s discretion.

 

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

 

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

 

Service Revenue

 

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

 

8

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*Recent AccountingPronouncements*

* *

In December 2004, the FASB issued SFAS No. 123(Revised 2004), “Share-Based Payment,” that addresses the accounting for share-basedpayment transactions in which a Company receives employee services in exchangefor (a) equity instruments of the Company or (b) liabilities that arebased on the fair value of the Company’s equity instruments or that may besettled by the issuance of such equity instruments. SFAS No. 123Raddresses all forms of share-based payment awards, including shares issuedunder employee stock purchase plans, stock options, restricted stock and stockappreciation rights. SFAS No. 123R eliminates the ability to account forshare-based compensation transactions using APB Opinion No. 25, “Accountingfor Stock Issued to Employees”, that was provided in Statement 123 asoriginally issued. Under SFAS No. 123R companies are required to recordcompensation expense for all share based payment award transactions measured atfair value. This statement is effective for quarters ending after June 15,2005. The Company has not yet determined the impact of applying the variousprovisions of SFAS No. 123R. Currently the Company uses the Black-Scholes option pricing model toestimate the fair value of stock options granted to employees and is evaluatingoption valuation models including the Black-Scholes to determine which modelthe Company will use upon the adoption of SFAS 123R.

 

In November 2004, the FASB issued SFAS No. 151“Inventory Costs”. This Statement amends the guidance in ARB No. 43,Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amountsof idle facility expense, freight, handling costs, and wasted material  (spoilage). In addition, this Statement requires that allocation of fixed productionoverhead to the costs of conversion be based on the normal capacity of theproduction facilities. The provisions of this Statement will be effective forthe Company beginning with its fiscal year ending 2005. The Company iscurrently evaluating the impact of this new standard, but believes that it willnot have a material impact on the Company’s financial position, results ofoperations or cash flows.

 

In December 2004, the FASB issued SFAS No. 153“Exchanges of Non-monetary Assets - an amendment of APB Opinion No. 29.”  This Statement amended APB Opinion No. 29to eliminate the exception for non-monetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of non-monetaryassets that do not have commercial substance. A non-monetary exchange hascommercial substance if the future cash flows of the entity are expected tochange significantly as a result of the exchange. The Company is currentlyevaluating the impact of this new standard, but believes that it will not havea material impact upon the Company’s financial position, results of operationsor cash flows.

 

In March 2005, the FASB issued FASBInterpretation (“FIN”) No. 47, “Accounting for Conditional AssetRetirement Obligations.” FIN No. 47 clarifies that the term conditionalasset retirement asset obligation as used in FASB Statement No. 143, “Accountingfor Asset Retirement Obligations,” refers to a legal obligation to perform anasset retirement activity in which the timing and/or method of settlement areconditional on a future event that may or may not be within the control of theentity. The obligation to perform the asset retirement activity is unconditionaleven though uncertainty exists about the timing and/or method of settlement.Uncertainty about the timing and/or method of settlement of a conditional assetretirement obligation should be factored into the measurement of the liabilitywhen sufficient information exists. This interpretation also clarifies when anentity would have sufficient information to reasonably estimate the fair valueof an asset retirement obligation. FIN No. 47 is effective no later thanthe end of fiscal years ending after December 15, 2005 (December 31,2005 for calendar-year companies). Retrospective application of interimfinancial information is permitted but is not required. Management does notexpect adoption of FIN No.47 to have a material impact on the Company’s financial statements.

 

9

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

 

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

 

As of April 30, 2005, the Company’s advances to PCA totaled approximately$950,000, which are evidenced by a secured note. The Company is in discussionswith PCA regarding the possibility of additional advances. The funds which havebeen advanced are to be used for general working capital to provide variousbrachytherapy services to ambulatory surgical centers. The secured note evidencingthe advances already made bears interest at 6% per annum and is repayable infour installments commencing on December 1, 2004, with all unpaidprincipal and interest due on September 1, 2005. To date, no payments havebeen received and the Company is uncertain when or whether these advances willbe repaid. As of April 30, 2005, the Company has expensed an amount equalto the amount advanced. If the Company made additional advances to PCA, theCompany would expense the amounts of such advances in the period of theadvance. The Company has no equity interest in PCA.  A distributor who has agreed to procure all ofits brachytherapy seeds exclusively from the Company through October 2008has a majority interest in PCA. Based on the terms of the lending and supplyagreements with the above entities, the Company determined that PCA is avariable interest entity (“VIE”) and the Company is the primary beneficiaryunder FIN No. 46 since PCA does not have sufficient equity at risk for theentity to finance its activities.

 

FIN No. 46 requires that an enterprise consolidate a VIE if thatenterprise has a variable interest that will absorb a majority of the entity’sexpected losses if they occur. Accordingly, the Company adopted FIN No. 46in October 2003 and consolidated PCA as a VIE, regardless of the Companynot having an equity interest in PCA and its creditors having no recourseagainst the Company.  The Companyconsolidated PCA in its Radiation Sources segment, to the extent of the Company’sloan of approximately $950,000.

 

Included in the Company’s consolidated balance sheet at April 30,2005, and October 31, 2004 were the following net assets of PCA:

 
| ** **                            | ** ** | **April 30,  2005** | ** ** | **October 31,  2004** | ** ** |
|---------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| Cash                                  |       | $                        | 11,000     |                       | $          | 473,000 |   |
| Accounts  receivable                  |       | —                   |       | 52,000                     |       |
| Prepaid and  other current assets     |       | (6,000                   | )          | 10,000                     |       |
| Equipment and  leasehold improvements |       | 661,000                  |       | 555,000                    |       |
| Other assets                          |       | 22,000                   |       | 33,000                     |       |
| Accounts payable                      |       | 1,000                    |       | (389,000                   | )          |
| Accrued expenses                      |       | (689,000                 | )          | (717,000                   | )          |
| Net assets                            |       | $                        | —     |                       | $          | 17,000 |   |

 

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

 

10

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| ** **  | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|-------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **  | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net revenue |       | $                                     | —     |                                | $          | — |   | $ | — |   | $ | — |   |
| Net loss    |       | —                                |       | (42,000                             | )          | (18,000 | ) | (238,000 | ) |
|             |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

**NOTE 3 – MARKETABLE SECURITIES**

** **

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

** **

**Debt securities that the Company has the positive intentand ability to hold to maturity are classified as “held-to-maturity” andreported at amortized cost. Debt securities not classified as held-to-maturityand marketable equity securities are classified as “available-for-sale,” and arerecorded at fair value with unrealized gains and losses included instockholders’ equity. As of April 30, 2005, all of the Company’smarketable securities are classified as held-to-maturity.**

** **

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

** **

**NOTE 4 – ACCOUNTSRECEIVABLE**

** **

Accounts receivable consist of the following:

 
| ** **                             | ** ** | **April 30,  2005** | ** ** | **October 31,  2004** | ** ** |
|----------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| Accounts  receivables                  |       | $                        | 8,107,000  |                       | $          | 7,757,000 |   |
| Less: allowance  for doubtful accounts |       | (879,000                 | )          | (625,000                   | )          |
|                                   |       | $                        | 7,228,000  |                       | $          | 7,132,000 |   |

 

11

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**NOTE 5 – INVENTORIES**

** **

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

 
| ** **      | ** ** | **April 30,  2005** | ** ** | **October 31,  2004** | ** ** |
|-----------------|------------|--------------------------|------------|----------------------------|------------|
| Raw materials   |       | $                        | 1,862,000  |                       | $          | 4,249,000 |   |
| Work in process |       | 94,000                   |       | 47,000                     |       |
| Finished goods  |       | 2,130,000                |       | 575,000                    |       |
|            |       | $                        | 4,086,000  |                       | $          | 4,871,000 |   |

** **

**NOTE 6 – NET LOSS PERSHARE**

** **

Basic earnings (loss) pershare iscomputed by dividing the net income (loss) by the weighted average number ofshares outstanding for the period. Diluted earnings (loss) per share iscomputed by dividing the net income (loss) by the sum of the weighted averagenumber of common shares outstanding for the period plus the assumed exercise ofall dilutive securities by applying the treasury stock method unless suchassumed exercises are anti-dilutive. The following table sets forth thecomputation of basic and diluted earnings (loss) per share:

 
| ** **                                     | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                           |       |                                  |       |                                |       |   |   |   |   |
| Net loss                                       |       | $                                     | (3,928,000 | )                                   | $          | (3,910,000 | ) | $ | (7,578,000 | ) | $ | (7,840,000 | ) |
| Weighted average  shares outstanding - basic   |       | 16,231,436                            |       | 10,338,011                          |       | 16,287,595 |   | 10,343,740 |   |
| Dilutive effect  of stock options and warrants |       | —                                |       | —                              |       | — |   | — |   |
| Weighted average  shares outstanding -diluted  |       | 16,231,436                            |       | 10,338,011                          |       | 16,287,595 |   | 10,343,740 |   |
| Basic loss per  share                          |       | $                                     | (0.24      | )                                   | $          | (0.38 | ) | $ | (0.47 | ) | $ | (0.76 | ) |
| Diluted loss per  share                        |       | $                                     | (0.24      | )                                   | $          | (0.38 | ) | $ | (0.47 | ) | $ | (0.76 | ) |

 

Stock options to purchase 3,044,963 and 2,539,150common shares for the three months ended April 30, 2005, and 2004,respectively, and  3,100,905 and2,587,039 common shares for the six months ended April 30, 2005 and 2004,respectively, were not included in the computation of diluted earnings pershare because their effect would have been anti-dilutive.

 

**NOTE 7 – ACQUISITION**

** **

On May 4, 2004, the Company acquired NOMOSCorporation (“NOMOS”). The results of NOMOS have been included in theconsolidated financial statements from the date of acquisition as the Company’sIMRT/IGRT business segment. NOMOS develops, markets andsells medical devices used in external beam radiation. As a result of theacquisition, the Company has expanded its product line, which the Companybelieves will allow it to compete more effectively in the radiation oncologymarket.

 

The NOMOS acquisition purchase price of approximately$58 million consisted of $11.5 million in cash, the issuance of 5.2 millionshares of the Company’s common stock with a fair value of approximately

 

12

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$37.3 million, the assumption of 1.4 million of stockoptions and warrants with a fair value of $4.6 million, direct transactioncosts of $3.0 million and the assumption of acquisition related liabilities of$1.6 million. The fair value of the common stock used in determining thepurchase price was $7.21 per share based on the average of the closing price ofthe common stock for the period two days before and two days after the October 27,2003 merger agreement announcement date. The stock options and warrants, whichfully vested at the acquisition date, were valued using a Black-Scholesvaluation model with the following assumptions: (i) risk-free interestrate of 4.5%, (ii) volatility factor of 60%, (iii) expected term of1.5 years for stock options, (iv) contractual term of 0.5 yearsfor warrants and (v) no dividend yield. The acquisition was accomplishedthrough a reverse triangular merger into a wholly owned subsidiary of theCompany, and is reflected in the Company’s financial statements, including thefootnotes thereto, as the IMRT/IGRT operating segment.

 

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

 
| ** **                             | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                   |       |                                  |       |                                |       |   |   |   |   |
| Revenue                                |       | $                                     | 9,141,000  |                                | $          | 11,246,000 |   | $ | 17,305,000 |   | $ | 21,010,000 |   |
| Net loss                               |       | (3,928,000                            | )          | (5,172,000                          | )          | (7,578,000 | ) | (12,866,000 | ) |
| Net loss per  share, basic and diluted |       | (0.24                                 | )          | (0.33                               | )          | (0.47 | ) | (0.83 | ) |
|                                        |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

** **

The unaudited pro forma financial information abovereflects the Company’s changes in revenue recognition policy. Prior to theacquisition by the Company, NOMOS had recognized revenue of the BAT productunder SAB No. 101 as a product in which software was deemed incidental.The Company has determined that revenue recognition of the BAT product shouldbe accounted for under SOP 97-2. The Company also determined that revenuerecognition of the BAT product should be deferred from the time of shipment, asNOMOS had historically recognized revenue, to the time of acceptance orinstallation. As a result of these changes in revenue recognition, the Companyhas presented the pro forma information above to be consistent with results presentedfor the three and six months ended April 30, 2005.

 

13

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**NOTE 8****– INTANGIBLE ASSETS**

 
| ** **                       | ** ** | **April 30, 2005**     | ** ** | **October 31, 2004**     | ** ** |
|----------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Amortizable  intangible assets   |       |                        |       |                          |       |   |   |   |   |
| Purchased  technology            |       | $                           | 24,232,000 |                          | $          | 1,752,000 |   | $ | 24,232,000 |   | $ | 884,000 |   |
| Existing  customer relationships |       | 1,952,000                   |       | 236,000                       |       | 1,952,000 |   | 120,000 |   |
| Trademark                        |       | 4,426,000                   |       | 329,000                       |       | 4,426,000 |   | 167,000 |   |
| Patents and  licenses            |       | 98,000                      |       | 37,000                        |       | 98,000 |   | 33,000 |   |
|                             |       | $                           | 30,708,000 |                          | $          | 2,354,000 |   | $ | 30,708,000 |   | $ | 1,204,000 |   |

 

Amortization expense was$575,000 and $11,000 for the three months ended April 30, 2005 and 2004,respectively, and $1,150,000 and $22,000 for the six months ended April 30,2005 and 2004, respectively.

 

The Company’s current estimateof aggregate amortization expense for subsequent years is as follows:

 
| **For the Years Ended April 30,** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|
|                                   |       |       |       |
| 2006                                   |       | $          | 2,319,000  |   |
| 2007                                   |       | 2,342,000  |       |
| 2008                                   |       | 2,330,000  |       |
| 2009                                   |       | 2,301,000  |       |
| 2010                                   |       | 2,273,000  |       |
| Thereafter                             |       | 16,789,000 |       |
|                                   |       | $          | 28,354,000 |   |

 

**NOTE 9**– DISCONTINUED OPERATION

 

In September 2004, the Company shut-down itsTheseus operation.  Effective with thefourth quarter of 2004, this segment is reflected as a discontinued operation.All prior period results have been restated accordingly, including thereallocation of fixed overhead charges to other business segments.

 

Revenues and loss from the discontinued operation wereas follows:

 
| ** **  | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|-------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **  | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|        |       |                                  |       |                                |       |   |   |   |   |
| Net revenue |       | $                                     | —     |                                | $          | — |   | $ | — |   | $ | — |   |
| Net loss    |       | —                                |       | (2,599,000                          | )          | — |   | (4,128,000 | ) |
|             |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

** **

**14**

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** **

Assets and liabilities of the discontinued operationswere as follows:

 
| ** **                                          | ** ** | **April 30,  2005** | ** ** | **October 31,  2004** | ** ** |
|-----------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| Cash                                                |       | $                        | (1,000     | )                          | $          | 186,000 |   |
| Other assets                                        |       | 16,000                   |       | 16,000                     |       |
| Accounts payable                                    |       | —                   |       | (45,000                    | )          |
| Accrued expenses                                    |       | (796,000                 | )          | (1,516,000                 | )          |
| Net assets  (liabilities) of discontinued operation |       | $                        | (781,000   | )                          | $          | (1,359,000 | ) |

 

**NOTE 10** – SEGMENTINFORMATION

 

**The Company operates two segments,Radiation Sources and IMRT/IGRT, based upon a combination of factors including:product produced, manufacturing process and management oversight.  Radiation Sources develops and marketradioisotopic products including brachytherapy seeds, accessories andcalibration sources used in the treatment of disease and used in other medical,environmental, research and industrial applications.  IMRT/IGRT develops and markets products usingexternal beam radiation therapy for the treatment of disease.**

** **

**The Company evaluates performanceand allocates resources based upon operating results and development milestones.  The accounting polices of the reportablesegments are the same as those described in Note 1 in the summary ofsignificant accounting policies.  Thereare no inter-company sales or profits.**

** **

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

** **
| ** **                | ** ** | **Three months ended April 30,** | ** ** | **Six months ended April 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenues**              |       |                                  |       |                                |       |   |   |   |   |
|                      |       |                                  |       |                                |       |   |   |   |   |
| IMRT/IGRT                 |       | $                                     | 6,074,000  |                                | $          | — |   | $ | 11,409,000 |   | $ | — |   |
| Radiation  Sources        |       | 3,067,000                             |       | 3,482,000                           |       | 5,896,000 |   | 6,845,000 |   |
|                      |       | $                                     | 9,141,000  |                                | $          | 3,482,000 |   | $ | 17,305,000 |   | $ | 6,845,000 |   |
|                      |       |                                  |       |                                |       |   |   |   |   |
| **Loss  from Operations** | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
|                      |       |                                  |       |                                |       |   |   |   |   |
| IMRT/IGRT                 |       | $                                     | (2,879,000 | )                                   | $          | — |   | $ | (5,516,000 | ) | $ | — |   |
| Radiation  Sources        |       | (1,104,000                            | )          | (1,475,000                          | )          | (2,185,000 | ) | (4,087,000 | ) |
|                      |       | $                                     | (3,983,000 | )                                   | $          | (1,475.000 | ) | $ | (7,701,000 | ) | $ | (4,087,000 | ) |

** **

**15**

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** **
| ** **              | ** ** | **April 30,  2005** | ** ** | **October 31,  2004** | ** ** |
|-------------------------|------------|--------------------------|------------|----------------------------|------------|
| **Goodwill**            |       |                     |       |                       |       |
| IMRT/IGRT               |       | $                        | 18,525,000 |                       | $          | 18,525,000 |   |
| Radiation  Sources      |       | 207,000                  |       | 207,000                    |       |
| Discontinued  operation |       | —                   |       | —                     |       |
|                    |       | $                        | 18,732,000 |                       | $          | 18,732,000 |   |
|                    |       |                     |       |                       |       |
| **Total  assets**       |       |                     |       |                       |       |
| IMRT/IGRT               |       | $                        | 60,522,000 |                       | $          | 61,719,000 |   |
| Radiation  Sources      |       | 9,569,000                |       | 18,608,000                 |       |
| Discontinued  operation |       | 15,000                   |       | 212,000                    |       |
|                    |       | $                        | 70,106,000 |                       | $          | 80,539,000 |   |

 

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

** **

The following discussion and analysis providesinformation, which our management believes is relevant to an assessment andunderstanding of our financial condition and results of operations. Thediscussion should be read in conjunction with the Consolidated FinancialStatements contained herein and the notes thereto. Certain statements containedin this 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 isdefined by: (i) the Private Securities Litigation Reform Act of 1995 (the “1995Act”) and (ii) releases issued by the Securities and Exchange Commission (“SEC”).These statements are being made pursuant to the provisions of the 1995 Act andwith the intention of obtaining the benefits of the “Safe Harbor” provisions ofthe 1995 Act. We caution that any forward looking statements made herein arenot guarantees of future performance and that actual results may differmaterially from those in such forward looking statements as a result of variousfactors, including, but not limited to, any risks detailed herein or detailedfrom time to time in our other filings with the SEC including our most recent annualreport on Form 10-K. We are not undertaking any obligation to updatepublicly any forward-looking statements. Readers should not place unduereliance on these forward-looking statements.

 

**Overview**

 

We manufacture, market and sell products principally forthe radiation oncology community, including intensity modulated and image guidedradiation therapy products and services, as well as radiation sources includingbrachytherapy seeds used in the treatment of prostate cancer.  Our business is organized into two operatingsegments: IMRT/IGRT and Radiation Sources. The Company discontinued Theseus Imaging (“Theseus”), our imagingsubsidiary, in September 2004, which had been developing aradiopharmaceutical agent intended initially to be used for the management ofchemotherapy treatment. For comparison purposes, the results of operations forTheseus have been presented as a discontinued operation.

 

IMRT/IGRT develops and markets intensity modulatedradiation therapy (“IMRT”) and image guided radiation therapy (“IGRT”) productsused in external beam radiation therapy for the treatment of disease.

 

16

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Radiation Sources develops and markets radioisotopicproducts including brachytherapy seeds, accessories and calibration sourcesused in the treatment of disease and used in medical, environmental, researchand industrial applications.

 

In May 2004, we acquired NOMOS Corporation (“NOMOS”).NOMOS was a privately held developer, manufacturer, and marketer of IMRT and IGRTproducts and services.  Under the termsof the merger agreement, we issued approximately 5.2 million shares of our commonstock and paid cash of approximately $11.5 million, in exchange for all of theoutstanding capital stock of NOMOS.  Wemanage this business as our IMRT/IGRT operating segment. Our results ofoperations, cash flows and balance sheet for the three and six months ended April 30,2005 include the results of NOMOS. Our 2004 fiscal year financials only beganto include NOMOS results from the date of the May 2004 acquisition.

 

**Resultsof Operations**

** **

**Three Months Ended April 30,2005 Compared to Three Months Ended April 30, 2004**

** **

**Revenue**.  Revenueincreased $5.6 million, or 163%, to $9.1 million for the three months ended April 30,2005, from $3.5 million for the three months ended April 30, 2004.  The increase in revenue during the quarterended April 30, 2005, is attributed to the acquisition of our IMRT/IGRTbusiness in May 2004 ($6.1 million) offset by a decrease in RadiationSources revenues ($0.4 million).

 

Product revenue increased $2.3 million, or 68% to $5.8million for the three months ended April 30, 2005, from $3.5 million forthe three months ended April 30, 2004. The increase in product revenue during the quarter ended April 30,2005, is attributed to the acquisition of our IMRT/IGRT business in May 2004($2.8 million) offset by a decrease in Radiation Sources revenues ($0.4 million).  The decline in Radiation Sources is due to adecline in unit volume.  During thisperiod the average selling price of our Radiation Sources’ products remainedconstant. We anticipate improvement in unit volume during the year due to therealignment of our sales force according to product lines and our continued pursuitof national accounts.

 

Service revenue increased $3.3 million for the threemonths ended April 30, 2005 from none for the three months ended April 30,2004, due to the acquisition of NOMOS.

 

**Gross profit**.  Gross profitincreased $2.1 million, or 136%, to $3.7 million for the three months ended April 30,2005, from $1.5 million for the three months ended April 30, 2004.  Gross profit as a percentage of revenuesdecreased from 44% to 40% during this period. The increase in gross profit is attributed to the acquisition of ourIMRT/IGRT business ($2.6 million) offset by a decrease in Radiation Sources($0.5 million).

 

Gross profit for the three months ended April 30,2005 consists of $2.6 million, or 43%, of revenue from our IMRT/IGRT businessand $1.0 million, or 34%, of revenue from our Radiation Sources business.

 

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

 

**Selling Expenses**.  Sellingexpenses include salaries, commissions and other related costs associated withour sales and marketing personnel and advertising, trade shows and otherpromotional programs. Selling expenses increased $1.3 million, or 154% to $2.2 millionfor the three months ended April 30, 2005, from

 

17

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$0.9 million for the three months ended April 30,2004.  The increase in selling expenses isprimarily attributed to the selling and marketing costs associated with the acquisitionof our IMRT/IGRT business.

 

**General and administrativeexpenses**. General and administrative (“G&A”) expenses include salaries andother related costs associated with finance, executive, human resources andinformation technology personnel and other administrative costs. G&Aexpenses increased $1.3 million, or 63%, to $3.3 million for the three monthsended April 30, 2005, from $2.0 million for the three months ended April 30,2004. The increase is primarily attributed to $1.4 million additionaladministrative costs associated with the acquisition of the IMRT/IGRT business,$0.5 million of severance costs related to a restructuring of our IMRT/IGRTbusiness and a $0.3 million increase to our reserve for doubtful accounts,partially offset by a $0.9 million reduction in administrative costs in ourRadiation Sources business.

 

**Research and development**.  Research anddevelopment (“R&D”) expenses include salaries and other related costsassociated with product development, third party development costs, overheadcosts and material used in development of prototypes. Our R&D costsincreased $1.4 million, or 948%, to $1.6 million for the three months ended April 30,2005, from $0.2 million for the three months ended April 30, 2004.  The increase is primarily attributed to the acquisitionof our IMRT/IGRT business.

 

**Amortization of intangible assets**.  Amortizationof intangible assets increased to $0.6 million for the three months ended April 30,2005 from $11,000 for the three months ended April 30, 2004.  The increase is attributed to theamortization of purchased intangibles acquired in the purchase of NOMOS.

 

**Interest and other income, net.** Interest and other income decreased $0.1 million, or 66%, to $0.1million for the three months ended April 30, 2005, from $0.2 million forthe three months ended April 30, 2004. The decrease is attributed to a smallerportfolio of marketable securities.

 

**Six Months Ended April 30,2005 Compared to Six Months Ended April 30, 2004**

** **

**Revenue**.  Revenueincreased $10.5 million, or 153%, to $17.3 million for the six months ended April 30,2005, from $6.8 million for the six months ended April 30, 2004.  The increase in revenue during the six monthsended April 30, 2005, is attributed to the acquisition of our IMRT/IGRTbusiness in May 2004 ($11.4 million) offset by a decrease in RadiationSources revenues ($0.9 million).

 

Product revenue increased $4.4 million, or 64% to $11.2million for the six months ended April 30, 2005, from $6.8 million for thesix months ended April 30, 2004. The increase in product revenue during the six months ended April 30,2005, is attributed to the acquisition of our IMRT/IGRT business in May 2004($5.3 million) offset by a decrease in Radiation Sources revenues ($0.9million).  The decline in RadiationSources is due to a decline in unit volume. During this period the average selling price of our Radiation Sources’products remained constant. We anticipate improvement in unit volume during theyear due to the realignment of our sales force according to product lines and ourcontinued pursuit of national accounts.

 

Service revenue increased $6.1 million for the sixmonths ended April 30, 2005 from none for the six months ended April 30,2004, due to the acquisition of NOMOS.

 

**Gross profit**.  Gross profitincreased $3.6 million, or 119%, to $6.6 million for the six months ended April 30,2005, from $3.0 million for the six months ended April 30, 2004.  Gross profit as a percentage of revenuesdecreased from 44% to 38% during this period. The increase in gross profit is attributed to the acquisition of ourIMRT/IGRT business ($4.8 million) offset by a decrease in Radiation Sources ($1.2million).

 

18

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Gross profit for the six months ended April 30,2005 consists of $4.8 million, or 42%, of revenue from our IMRT/IGRT businessand $1.8 million, or 30%, of revenue from our Radiation Sources business.

 

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

 

**Selling Expenses**.  Sellingexpenses include salaries, commissions and other related costs associated withour sales and marketing personnel and advertising, trade shows and otherpromotional programs. Selling expenses increased $2.7 million, or 164% to $4.3million for the six months ended April 30, 2005, from $1.6 million for thesix months ended April 30, 2004. The increase in selling expenses is primarily attributed to the sellingand marketing costs associated with the acquisition of our IMRT/IGRT business.

 

**General and administrativeexpenses**. General and administrative (“G&A”) expenses include salaries andother related costs associated with finance, executive, human resources andinformation technology personnel and other administrative costs. G&Aexpenses increased $0.5 million, or 9%, to $5.6 million for the six monthsended April 30, 2005, from $5.1 million for the six months ended April 30,2004. The increase is primarily attributed to $2.7 million additionaladministrative costs associated with the acquisition of the IMRT/IGRT business,$0.5 million of severance costs related to the restructuring of the IMRT/IGRTbusiness, and a $0.3 million increase in our reserve for doubtful accounts,partially offset by the inclusion of $1.0 million severance paid to a formerofficer of the Company in the six months ended April 30, 2004, and $2.0million reduction in administrative costs in our Radiation Sources business.

 

**Research and development**.  Research anddevelopment (“R&D”) expenses include salaries and other related costsassociated with product development, third party development costs, overheadcosts and material used in development of prototypes. Our R&D costsincreased $2.9 million, or 914%, to $3.3 million for the six months ended April 30,2005, from $0.3 million for the six months ended April 30, 2004.  The increase is primarily attributed to theacquisition of our IMRT/IGRT business.

 

**Amortization of intangible assets**.  Amortizationof intangible assets increased to $1.2 million for the six months ended April 30,2005 from $22,000 for the six months ended April 30, 2004.  The increase is attributed to the amortizationof purchased intangibles acquired in the purchase of NOMOS.

 

**Interest and other income, net.** Interest and other income decreased $0.3 million, or 67%, to $0.1million for the six months ended April 30, 2005, from $0.4 million for thesix months ended April 30, 2004. The decrease is attributed to a smallerportfolio of marketable securities

 

**Liquidity and Capital Resources**

** **

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

 

We believe that our existing cash resources and forecastedoperating cash flow under our current operating plan will be sufficient to meetour working capital requirements for at least the next twelve months. Our plan isto return to profitability and to generate positive cash flows by increasingrevenues from existing and new products and services, realizing the benefits ofthe integration of the historic company and NOMOS operations and focusing oncost control. However, there is no assurance that we will be

 

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successful with these plans. If events andcircumstances occur such that we do not meet our current operating plan asexpected, we may need to raise additional financing, and we may be required tofurther reduce certain discretionary spending, which could have a materialadverse effect on our ability to achieve our intended business objectives. Weexpect that we will be able to satisfy our longer term liquidity needs forresearch and development, capital expenditures, and acquisitions through acombination of cash generated by operations, future public offerings andprivate placements of our common stock, and bank lines of credit.

 

At April 30, 2005, we had cash, and cashequivalents, and investments in marketable securities aggregating approximately$6.4 million, a decrease of approximately $8.6 million from $15.0 million at October 31,2004. The decrease was primarily attributed to $8.1 million used in continuingoperations, $0.5 million used in our discontinued operation and $0.2 millionused for capital expenditures, offset by $0.2 million in cash received from theexercise of stock options and the employee stock purchase plan.

 

Cash flows used in operating activities increased $0.7million or 7% to $8.6 million for the six months ended April 30, 2005 from$7.8 million for the six months ended April 30, 2004.  The increase in cash used in operatingactivities reflects payment of accounts payable and accrued expenses and anincrease in accounts receivable partially offset by a reduction of cash used inour discontinued operation ($4.1 million). We expect that cash used inoperating activities may fluctuate in future periods as a result of a number offactors, including fluctuations in our operating results, accounts receivablecollections, inventory management, research and development expenses, and thetiming of payments.

 

Cash flows provided by investing activities increased $0.5million or 9% to $6.3 million for the six months ended April 30, 2005,from $5.8 million for the six months ended April 30, 2004.  The increase reflects a greater need to drawdown our balance of marketable securities to fund operations ($1.3 million) partiallyoffset by a decrease in spending on capital expenditures ($0.8 million).

 

Cash provided by financing activities decreased $1.1million or 83% to $0.2 million for the six months ended April 30, 2005,from $1.3 million for the six months ended April 30, 2004.  The decrease reflects a reduction in theproceeds from exercise of employee stock options.

 

We have $4.1 million in operating lease obligationsfor facilities and equipment under non-cancelable operating lease agreements.

 

**CriticalAccounting Policies**

** **

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

 

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*Revenue Recognition*

 

We sell products principallyfor the radiation oncology community, including IMRT and IGRT products andservices, as well as brachytherapy seeds used in the treatment of cancer. Product revenue consists of brachytherapy, non-therapeutic sources, certainIMRT hardware devices and software products including IMRT treatment planningand delivery systems and our IGRT system. Service revenue consists of warranty revenue from product sales andmaintenance service agreements.

 

Product revenue

 

We apply theprovisions of SEC Staff Accounting Bulletin (“SAB”) No. 104, “RevenueRecognition” for the sale of non-software products.  SAB No. 104which supersedes SAB No. 101, “Revenue Recognition in Financial Statements”,provides guidance on the recognition, presentation and disclosure of revenue infinancial statements.  SAB No. 104 outlines the basic criteria thatmust be met to recognize revenue and provides guidance for the disclosure ofrevenue recognition policies.  In general, we recognize revenue related toproduct sales when (i) persuasive evidence of an arrangement exists, (ii) deliveryhas occurred, (iii) the fee is fixed or determinable, and (iv) collectibility is reasonably assured.

 

Revenuerecognition is deferred when undelivered products or services are essential tothe functionality of delivered products, customer acceptance is uncertain,significant obligations remain, or the fair value of undelivered elements isunknown or collectibility is uncertain.

 

Our softwareproduct revenue is generated from the sale of advanced medical equipmentproducts.  The software element of our products is deemed an essentialelement of the functionality of the product.  Maintenance and support areprovided with the initial product sale for a twelve month period.  Themaintenance and support is renewable annually or longer, at the customer’sdiscretion.

 

We recognize softwarerevenue 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 (“SOP98-9”), “Modification of SOP 97-2, Software Revenue Recognition, with respectto Certain Transactions”.  Under the provisions of SOP 97-2, we recognizesoftware revenue upon delivery and acceptance, provided all significantobligations have been met, persuasive evidence of an arrangement exists, feesare fixed or determinable, collection is probable, and we are not involved inproviding services that are essential to the functionality of the product.

 

Our software salesare 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 elementbased on the relative fair value of the elements.  If the fair value ofthe element exists, the determination is based on vendor specific objectiveevidence.  If such evidence of fair value for each element of thearrangement does not exist, all revenue from the arrangement is deferred untilsuch time that evidence of fair value of each element does exist or until allelements of the arrangement are delivered.  If in a multiple elementarrangement, fair value does not exist for one or more of the undeliveredelements, the residual method of accounting is applied.  Under theresidual method, the fair value of the undelivered elements is deferred, andthe remaining portion of the arrangement fee is recognized as revenue.

 

Service revenue

 

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

 

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*Allowancefor Doubtful Accounts and Sales Returns*

 

The allowance for doubtful accounts is based on ourassessment of the collectibility of specific customer accounts and the aging ofthe accounts receivable. We regularly review the allowance by consideringfactors such as historical experience, age of the accounts receivable balancesand current economic conditions that may affect a customer’s ability to pay. Ifthere was a deterioration of a major customer’s credit worthiness or actualdefaults are higher than our historical experience, our estimates of therecoverability of amounts due us could be overstated which could have anadverse impact on our financial results.

 

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

 

*Goodwilland Other Intangible Assets*

 

SFAS 142, Goodwilland Other Intangible Assets, requires that goodwill be tested for impairment atthe reporting unit level (operating segment level or one level below anoperating segment) on an annual basis (August 31st) and between annualtests if an event occurs or circumstances change that would more likely thannot reduce the fair value of a reporting unit below its carrying value. Theseevents or circumstances could include a significant change in the businessclimate, legal factors, operating performance indicators, competition, sale ordisposition of a significant portion of a reporting unit. Application of thegoodwill impairment test requires management to make various judgments,including the identification of reporting units, assignment of assets andliabilities to reporting units, assignment of goodwill to reporting units, anddetermination of the fair value of each reporting unit. The fair value of eachreporting unit is estimated using a discounted cash flow methodology. Thisrequires significant judgments including estimation of future cash flows, whichis dependent on internal forecasts, estimation of the long-term rate of growthfor our business, the useful life over which cash flows will occur, anddetermination of our weighted average cost of capital. Changes in theseestimates and assumptions could materially affect the determination of fairvalue and/or goodwill impairment for each reporting unit.

 

*Research and Development Costs*

 

We account for research and development costs inaccordance with several accounting pronouncements, including SFAS 2, Accountingfor Research and Development Costs, and SFAS 86, Accounting for the Costs ofComputer Software to be Sold, Leased, or Otherwise Marketed. SFAS 86 specifiesthat costs incurred internally in researching and developing a computersoftware product should be charged to expense until technological feasibilityhas been established for the product. Once technological feasibility isestablished, all software costs should be capitalized until the product isavailable for general release to customers. Judgment is required in determiningwhen technological feasibility of a product is established. We have determinedthat technological feasibility for our software products is reached shortlybefore the products are released to manufacturing. Costs incurred aftertechnological feasibility is established are not material, and accordingly, weexpense all research and development costs when incurred.

 

*LossContingencies*

 

We record liabilities related to pending litigationwhen an unfavorable outcome is probable and we can reasonably estimate theamount 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 unfavorableoutcome and an estimate of the amount of the loss. Significant

 

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judgment is required in both the determination ofthe probability and as to whether an exposure can be reasonably estimated. Whenwe determine that it is probable that a loss has been incurred, the effect isrecorded promptly in the consolidated financial statements. Although theoutcome of these claims cannot be predicted with certainty, we do not believethat any of our existing legal matters will have a material adverse effect onour financial condition or results of operations.

 

*IncomeTaxes*

 

We account for income taxes using the liabilitymethod. Deferred taxes are determined based on the differences between thefinancial statement and tax bases of assets and liabilities, using enacted taxrates in effect for the year in which the differences are expected to reverse.Valuation allowances are established when necessary to reduce deferred taxassets to the amounts expected to be realized. In addition, we are subject toexamination of our income tax returns by the Internal Revenue Service and othertax authorities. We regularly assess the likelihood of adverse outcomesresulting from these examinations.

 

**RecentAccounting Pronouncements**

** **

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

 

In November 2004, the FASB issued SFAS No. 151“Inventory Costs”. This Statement amends the guidance in ARB No. 43, Chapter4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idlefacility expense, freight, handling costs, and wasted material (spoilage).  In addition, this Statement requires thatallocation of fixed production overhead to the costs of conversion be based onthe normal capacity of the production facilities. The provisions of thisStatement will be effective for us beginning with our fiscal year ending 2005. Weare currently evaluating the impact of this new standard, but we do not believethat it will have a material impact on our financial position, results ofoperations or cash flows.

 

In December 2004, the FASB issued SFAS No. 153“Exchanges of Non-monetary Assets - an amendment of APB Opinion No.  29”.  This Statementamended APB Opinion No. 29 to eliminate the exception for non-monetaryexchanges of similar productive assets and replaces it with a general exceptionfor exchanges of non-monetary assets that do not have commercial substance. Anon-monetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. We arecurrently evaluating the impact of this new standard, but we do not believethat it will have a material impact upon our financial position, results ofoperations or cash flows.

 

In March 2005, the FASB issued FASBInterpretation (“FIN”) No. 47, “Accounting for Conditional AssetRetirement Obligations.” FIN No. 47 clarifies that the term conditionalasset retirement asset obligation as used in FASB Statement No. 143, “Accountingfor Asset Retirement Obligations,” refers to a legal

 

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obligation to perform an asset retirement activityin which the timing and/or method of settlement are conditional on a futureevent that may or may not be within the control of the entity. The obligationto perform the asset retirement activity is unconditional even thoughuncertainty exists about the timing and/or method of settlement. Uncertaintyabout the timing and/or method of settlement of a conditional asset retirementobligation should be factored into the measurement of the liability whensufficient information exists. This interpretation also clarifies when anentity would have sufficient information to reasonably estimate the fair valueof an asset retirement obligation. FIN No. 47 is effective no later thanthe end of fiscal years ending after December 15, 2005 (December 31,2005 for calendar-year companies). Retrospective application of interimfinancial information is permitted but is not required. Management does notexpect adoption of FIN No.47 to have a material impact on the Company’s financial statements.

 

###### **Item3**.  Quantitativeand Qualitative Disclosures about Market Risk

###### ** **

Information about market risks for the three and six monthsended April 30, 2005, does not differ materially from that discussed underItem 7A of the registrant’s Annual Report on Form 10-K for the fiscal yearended October 31, 2004.

 

###### **Item4**.  Controlsand Procedures

###### ** **

(a)  Evaluation of Disclosure Controls andProcedures

 

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

 

(b)  Changes in Internal Controls

 

There has been no change in our internal control overfinancial reporting during the quarter or six months ended April 30, 2005,that has materially affected or is reasonably like to materially affect ourinternal control over financial reporting.

 

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**PART II****– OTHER INFORMATION**

 

**The Company was not required toreport the information pursuant to Items 1 through 6 of Part II of Form 10-Qexcept as follows:**

** **

## **Item6.**  Exhibits

## ** **

(a)          Exhibits.

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

 

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**SIGNATURES**

 

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

 

 
|              | NORTH AMERICAN SCIENTIFIC, INC. |
|-------------------|---------------------------------|
|              |                            |   |
|              |                            |   |
| June 9, 2005 | By:                             | /s/ L. Michael Cutrer |   |
|              |                            | Name: | L. Michael Cutrer |
|              |                            | Title: | President and |
|              |                            |   | Chief Executive Officer |
|              |                            |   | (Principal Executive Officer) |
|              |                            |   |
|              |                            |   |
| June 9, 2005 | By:                             | /s/ James W. Klingler |   |
|              |                            | Name: | James W. Klingler |
|              |                            | Title: | Senior Vice President and |
|              |                            |   | Chief Financial Officer |
|              |                            |   | (Principal Financial Officer) |
|                   |                                 |  |  |  |

 

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