#### ** **

#### **UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

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**FORM 10-Q/A**

#### **(AmendmentNo. 2)**

 

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

 

**For the quarterly periodended July 31, 2004**

** **

**or**

 

**o****TRANSITION REPORT PURSUANTTO 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 registrant as specified in itscharter)

 

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

 

ýYes    o  No

 

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

 

ýYes    o  No

 

The number of shares of Registrant’s Common Stock,$.01 par value, outstanding as of September 20, 2004 was 16,257,437shares.

 

 

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**NORTH AMERICANSCIENTIFIC, INC.**

 

**EXPLANATORY NOTE FOR FILING OF FORM 10-Q/A**

 

This amendment No. 2 to North America Scientific, Inc.’s (the “Company”)Quarterly Report on Form 10-Q for the quarterly period ended July 31, 2004,which was originally filed on September 20, 2004 (the “Original Filing”)and subsequently amended on September 21, 2004 (the “First Amendment”),amends Items 1 and 2 of Part I and Item 6 of Part II of Form 10-Q to remove thedisclosure in Note 1 of Item 1 “Financial Statements”, Item 2 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andItem 6. Exhibit 32.1 that a review had not been completed by the Company’sindependent registered public accounting firm.

 

                                                Inaccordance with Rule 12b-15 of the Securities Exchange Act of 1934, thefollowing Items of the First Amendment are amended in their entirety and thecomplete text of those Items is set out in this Amendment No. 2:

 

Part I                                                                    FinancialInformation

 

Item 1.                                                             FinancialStatements

 

Item 2.                                                             Management’sDiscussion and Analysis of Financial Condition and

                                                                                                Resultsof  Operations.

 

Part II                                                                OtherInformation

 

Item 6.                                                             Exhibits

 

The other Items of the First Amendment are unaffected by the changesdescribed above and have not been amended in this Amendment No. 2.  All information in this Amendment No. 2 toForm 10-Q is as of the date of the First Amendment and does not reflect anysubsequent information or events occurring after the date of the FirstAmendment.

 

**Index**

 
| **Part I – Financial  Information**                                                                    | ** **                                                                                      |
|-------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                                                                                                  | ** **                                                                                      | ** ** |
| **Item 1.**                                                                                                 | **Financial Statements**                                                                        | ** ** |
| ** **                                                                                                  | ** **                                                                                      | ** ** |
| **Consolidated Balance Sheets  as of July 31, 2004 and October 31, 2003**                         | ** **                                                                                      |
| ** **                                                                                                  | ** **                                                                                      | ** ** |
| **Consolidated  Statements of Operations for the three and nine months ended July 31,  2004 and 2003** | ** **                                                                                      |
| ** **                                                                                                  | ** **                                                                                      | ** ** |
| **Consolidated  Statements of Cash Flows for the nine months ended July 31, 2004 and  2003**           | ** **                                                                                      |
| ** **                                                                                                  | ** **                                                                                      | ** ** |
| **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  4.**                                                                                                | **Submission  of Matters to a Vote of Security Holders**                                        | ** ** |
| ** **                                                                                                  | ** **                                                                                      | ** ** |
| **Item 6.**                                                                                                 | **Exhibits**                                                                                    | ** ** |
| ** **                                                                                                  | ** **                                                                                      | ** ** |
| **Signatures**                                                                                              | ** **                                                                                      | ** ** |

 

2

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**PART II – FINANCIAL INFORMATION**

 

###### **Item 1.   Financial Statements**

###### ** **

**NORTH AMERICAN SCIENTIFIC, INC.**

** **

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                             | ** ** | **July 31,  2004** | ** ** | **October 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                                             | ** ** | **(Unaudited)**         | ** ** | ** **                 | ** ** |
|                                                                                                                                                                                                                   |       |                    |       |                       |       |
| **Assets**                                                                                                                                                                                                             |       |                    |       |                       |       |
|                                                                                                                                                                                                                   |       |                    |       |                       |       |
| Current Assets                                                                                                                                                                                                         |       |                    |       |                       |       |
| Cash                                                                                                                                                                                                                   |       | $                       | 232,000    |                       | $          | 1,761,000 |   |
| Marketable securities                                                                                                                                                                                                  |       | 14,481,000              |       | 32,587,000                 |       |
| Accounts receivable                                                                                                                                                                                                    |       | 6,772,000               |       | 2,167,000                  |       |
| Inventories                                                                                                                                                                                                            |       | 6,529,000               |       | 692,000                    |       |
| Income tax receivable                                                                                                                                                                                                  |       | —                  |       | 496,000                    |       |
| Prepaid and other current assets                                                                                                                                                                                       |       | 2,929,000               |       | 1,053,000                  |       |
| Total  current assets                                                                                                                                                                                                  |       | 30,943,000              |       | 38,756,000                 |       |
| Non-current marketable securities                                                                                                                                                                                 |       | 8,362,000               |       | 14,767,000                 |       |
| Equipment and leasehold improvements                                                                                                                                                                                   |       | 4,315,000               |       | 2,996,000                  |       |
| Goodwill                                                                                                                                                                                                               |       | 22,932,000              |       | 3,866,000                  |       |
| Intangible assets                                                                                                                                                                                                      |       | 27,426,000              |       | 813,000                    |       |
| Other assets                                                                                                                                                                                                           |       | 122,000                 |       | 1,334,000                  |       |
| Total  assets                                                                                                                                                                                                          |       | $                       | 94,100,000 |                       | $          | 62,532,000 |   |
|                                                                                                                                                                                                                   |       |                    |       |                       |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                          |       |                    |       |                       |       |
|                                                                                                                                                                                                                   |       |                    |       |                       |       |
| Current liabilities                                                                                                                                                                                                    |       |                    |       |                       |       |
| Accounts payable                                                                                                                                                                                                       |       | $                       | 5,196,000  |                       | $          | 1,620,000 |   |
| Accrued expenses                                                                                                                                                                                                       |       | 8,120,000               |       | 5,166,000                  |       |
| Deferred revenue                                                                                                                                                                                                       |       | 5,786,000               |       | —                     |       |
| Total current liabilities                                                                                                                                                                                              |       | 19,102,000              |       | 6,786,000                  |       |
|                                                                                                                                                                                                                   |       |                    |       |                       |       |
| 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, 16,276,437 and 10,298,241 shares issued; 16,257,437 and  10,279,241 shares outstanding as of July 31, 2004 and October 31,  2003, respectively |       | 166,000                 |       | 103,000                    |       |
| Additional paid-in capital                                                                                                                                                                                             |       | 120,818,000             |       | 74,343,000                 |       |
| Treasury stock, at cost – 19,000 shares                                                                                                                                                                           |       | (129,000                | )          | (129,000                   | )          |
| Accumulated deficit                                                                                                                                                                                                    |       | (45,857,000             | )          | (18,571,000                | )          |
| Total stockholders’ equity                                                                                                                                                                                        |       | 74,998,000              |       | 55,746,000                 |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                        |       | $                       | 94,100,000 |                       | $          | 62,532,000 |   |

 

See condensed notes to the consolidated financial statements.

 

3

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**NORTH AMERICAN SCIENTIFIC, INC.**

 

**Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                                                       | ** ** | **Three months ended July 31,** | ** **  | **Nine months ended July 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------|-------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                             | ** **  | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Net Sales                                                        |       | $                                    | 8,137,000   |                                | $          | 3,011,000 |   | $ | 14,982,000 |   | $ | 11,056,000 |   |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Cost of goods sold                                               |       | 4,801,000                            |        | 1,733,000                           |       | 8,639,000 |   | 4,988,000 |   |
| Gross profit                                                     |       | 3,336,000                            |        | 1,278,000                           |       | 6,343,000 |   | 6,068,000 |   |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Selling expenses                                                 |       | 2,273,000                            |        | 889,000                             |       | 3,919,000 |   | 2,463,000 |   |
| General and administrative expenses                              |       | 3,817,000                            |        | 1,815,000                           |       | 9,602,000 |   | 5,686,000 |   |
| Research and development                                         |       | 3,269,000                            |        | 1,661,000                           |       | 7,060,000 |   | 5,431,000 |   |
| In-process research and development                              |       | 7,800,000                            |        | —                              |       | 7,800,000 |   | — |   |
| Impairment of goodwill and long-lived  assets                    |       | 4,681,000                            |        | —                              |       | 4,681,000 |   | — |   |
| Merger and integration costs                                     |       | 1,056,000                            |        | —                              |       | 1,056,000 |   | — |   |
| Loss from operations                                             |       | (19,560,000                          | )           | (3,087,000                          | )          | (27,775,000 | ) | (7,512,000 | ) |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Interest and other income, net                                   |       | 114,000                              |        | 250,000                             |       | 489,000 |   | 1,534,000 |   |
| Loss before provision for income taxes                           |       | (19,446,000                          | )           | (2,837,000                          | )          | (27,286,000 | ) | (5,978,000 | ) |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Provision for income taxes                                       |       | —                               |        | —                              |       | — |   | — |   |
| Loss before cumulative effect of change in  accounting principle |       | (19,446,000                          | )           | (2,837,000                          | )          | (27,286,000 | ) | (5,978,000 | ) |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Cumulative effect of change in accounting  principle             |       | —                               |        | —                              |       | — |   | 311,000 |   |
| Net loss                                                         |       | $                                    | (19,446,000 | )                                   | $          | (2,837,000 | ) | $ | (27,286,000 | ) | $ | (6,289,000 | ) |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Basic and diluted loss per share:                                |       |                                 |        |                                |       |   |   |   |   |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Loss before cumulative effect of change in  accounting principle |       | $                                    | (1.24       | )                                   | $          | (0.28 | ) | $ | (2.24 | ) | $ | (0.58 | ) |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Cumulative effect of change in accounting principle              |       | —                               |        | —                              |       | — |   | (0.03 | ) |
| Net loss                                                         |       | $                                    | (1.24       | )                                   | $          | (0.28 | ) | $ | (2.24 | ) | $ | (0.61 | ) |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Shares used in per share calculations:                           |       |                                 |        |                                |       |   |   |   |   |
|                                                             |       |                                 |        |                                |       |   |   |   |   |
| Basic and diluted                                                |       | 15,679,214                           |        | 10,259,002                          |       | 12,193,057 |   | 10,252,661 |   |

 

See condensed notes to the consolidated financial statements.

 

4

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**NORTH AMERICAN SCIENTIFIC, INC.**

 

**Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Nine Months Ended July 31,** | ** **  |
|------------------------------------------------------------------------------|------------|-------------------------------------|-------------|
| ** **                                                                   | ** ** | **2004**                            | ** **  | **2003** | ** ** |
| Cash flows from operating activities:                                        |       |                                |        |   |   |
| Net loss                                                                     |       | $                                   | (27,286,000 | ) | $ | (6,289,000 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                |        |   |   |
| Cumulative effect of change in accounting  principle                         |       | —                              |        | 311,000 |   |
| Depreciation and amortization                                                |       | 1,280,000                           |        | 698,000 |   |
| Stock-based compensation                                                     |       | 351,000                             |        | 47,000 |   |
| Provision for doubtful accounts                                              |       | 44,000                              |        | 17,000 |   |
| Gain on sale of marketable securities                                        |       | —                              |        | (600,000 | ) |
| Impairment of long-lived assets                                              |       | 4,681,000                           |        | — |   |
| Write-off of in-process research and  development                            |       | 7,800,000                           |        | — |   |
| Write-off of licenses and equipment                                          |       | 14,000                              |        | 217,000 |   |
| Changes in assets and liabilities, net of  effects of acquisition:           |       |                                |        |   |   |
| Accounts receivable                                                          |       | (1,742,000                          | )           | 375,000 |   |
| Inventories                                                                  |       | (1,244,000                          | )           | (127,000 | ) |
| Prepaid and other current assets                                             |       | (158,000                            | )           | (440,000 | ) |
| Accounts payable                                                             |       | 1,483,000                           |        | (57,000 | ) |
| Accrued expenses                                                             |       | (1,849,000                          | )           | 462,000 |   |
| Income tax receivable                                                        |       | 496,000                             |        | 1,006,000 |   |
| Deferred revenue                                                             |       | 1,046,000                           |        | — |   |
| Net cash used in operating activities                                        |       | (15,084,000                         | )           | (4,380,000 | ) |
|                                                                         |       |                                |        |   |   |
| Cash flows from investing activities:                                        |       |                                |        |   |   |
| Proceeds from sale of marketable securities                                  |       | 40,886,000                          |        | 28,434,000 |   |
| Purchase of marketable securities                                            |       | (16,375,000                         | )           | (24,766,000 | ) |
| Proceeds from sale of non-marketable  securities                             |       | —                              |        | 408,000 |   |
| Purchase of licenses                                                         |       | (75,000                             | )           | (35,000 | ) |
| NOMOS acquisition, net of cash acquired                                      |       | (13,248,000                         | )           | — |   |
| Capital expenditures                                                         |       | (1,251,000                          | )           | (376,000 | ) |
| Net cash provided by investing activities                                    |       | 9,937,000                           |        | 3,665,000 |   |
|                                                                         |       |                                |        |   |   |
| Cash flow from financing activities:                                         |       |                                |        |   |   |
| Purchase of common stock                                                     |       | —                              |        | (129,000 | ) |
| Proceeds from exercise of stock options and  stock purchase plan             |       | 3,618,000                           |        | 171,000 |   |
| Net cash provided by finance activities                                      |       | 3,618,000                           |        | 42,000 |   |
| Net decrease in cash and cash equivalents                                    |       | (1,529,000                          | )           | (673,000 | ) |
|                                                                         |       |                                |        |   |   |
| Cash and cash equivalents at beginning of  period                            |       | 1,761,000                           |        | 2,708,000 |   |
| Cash and cash equivalents at end of period                                   |       | $                                   | 232,000     |   | $ | 2,035,000 |   |

 

See condensed notes to the consolidated financial statements.

 

5

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**NORTH AMERICAN SCIENTIFIC, INC.**

 

**Condensed Notes to Consolidated FinancialStatements**

**(Unaudited)**

 

**Note 1 – Consolidated Financial Statements**

 

*Basisof Presentation*

* *

The accompanyingconsolidated financial statements of North American Scientific, Inc. (“Company”)are unaudited, other than the consolidated balance sheet at October 31,2003, and reflect all material adjustments, consisting only of normal recurringadjustments, which management considers necessary for a fair statement of theCompany’s financial position, results of operations and cash flows for theinterim periods.  The results ofoperations for the current interim period are not necessarily indicative of theresults to be expected for the entire fiscal year.

 

These consolidatedfinancial statements have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnotes normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles in the United States of America have been condensed oromitted pursuant to these rules and regulations.  These consolidated financial statementsshould be read in conjunction with the consolidated financial statements andthe notes thereto included in the Company’s Form 10-K, as filed with the SECfor the year ended October 31, 2003.

 

Certain reclassificationshave been made to prior period balances in order to conform to the currentperiod presentation.

 

*Management’s Plans*

 

Theaccompanying financial statements have been prepared on a going concern basis, whichcontemplates the realization of assets and liquidation of liabilities in thenormal course of business.  The Company has incurred net losses of$27,286,000 and $9,440,000 for the nine months ended July 31, 2004 and thefiscal year ended October 31, 2003, respectively, and has used cash inoperations of $15,084,000 and $6,263,000 for the nine months ended July 31,2004 and the fiscal year ended October 31, 2003, respectively.  As ofJuly 31, 2004, the company has cash, cash equivalents and marketablesecurities of $23,075,000, no long-term debt, and an accumulated deficit of$45,857,000.

 

Basedon the Company’s current operating plans, management believes existing cashresources and cash forecasted by management to be generated by operations willbe sufficient to meet working capital and capital requirements through at leastthe next twelve months. Also, management’s plans to attain profitability andgenerate additional cash flows include increasing revenues from existing andnew products and services, realizing the benefits of the integration of NASIand NOMOS operations and a focus on cost control.  There is no assurancethat management will be successful with these plans.  However, if eventsand circumstances occur such that the Company does not meet its currentoperating plan as expected, incurs significant losses, and the Company is unableto raise additional financing, the Company may be required to further reducecertain discretionary spending, which could have a material adverse effect onthe Company’s ability to achieve its intended business objectives.

 

*Useof Estimates*

* *

In the normal course ofpreparing the financial statements in conformity with generally acceptedaccounting principles in the United States of America, management is requiredto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and reported amounts of revenue and expenses duringthe reporting period.  Actual resultscould differ from those amounts.

 

*Accountingfor Stock-based Compensation*

* *

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

 

6

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Had compensation cost forthe Company’s stock options been recognized based upon the estimated fair valueon the grant date under the fair value methodology prescribed by SFAS No. 123,as amended by SFAS No. 148, the Company’s net loss and loss per share wouldhave been as follows:

 
| ** **                                     | ** ** | **Three months ended July 31,** | ** **  | **Nine months ended July 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|-------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2004**                             | ** **  | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss, as reported                          |       | $                                    | (19,446,000 | )                                   | $          | (2,837,000 | ) | $ | (27,286,000 | ) | $ | (6,289,000 | ) |
| Add: stock-based compensation recognized       |       | —                               |        | —                              |       | 351,000 |   | 47,000 |   |
| Less: total stock-based compensation (1)       |       | (450,000                             | )           | (539,000                            | )          | (2,048,000 | ) | (1,666,000 | ) |
| Net loss, as adjusted                          |       | $                                    | (19,896,000 | )                                   | $          | (3,376,000 | ) | $ | (28,983,000 | ) | $ | (7,908,000 | ) |
| Basic and diluted loss per share, as  reported |       | $                                    | (1.24       | )                                   | $          | (0.28 | ) | $ | (2.24 | ) | $ | (0.61 | ) |
| Basic and diluted loss per share, as  adjusted |       | $                                    | (1.27       | )                                   | $          | (0.33 | ) | $ | (2.38 | ) | $ | (0.77 | ) |

 

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**(1) Asdetermined under the fair value method.**

** **

**The Company uses the Black-Scholesoption-pricing model for estimating the fair value of options granted. TheBlack-Scholes option-pricing model was developed for use in estimating the fairvalue of traded options that have no vesting restrictions and are fullytransferable.  In addition, optionvaluation models require the input of highly subjective assumptions, includingthe expected stock price volatility.  TheCompany uses projected volatility rates, which are based upon historicalvolatility rates, trended into future years. Because the Company’s employeestock options have characteristics significantly different from those of tradedoptions, and because changes in the subjective input assumptions can materiallyaffect the fair value estimate, in management’s opinion, the existing models donot necessarily 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 sellsproducts for the radiation oncology community, including brachytherapy seedsused in the treatment of cancer, as well as intensity modulated radiationtherapy (“IMRT”) and image guidance radiation therapy (“IGRT”) products andservices.  Product revenue consists ofbrachytherapy and related products sales. Software revenues consist of IMRT and IGRT product sales.

 

Product revenue

 

The Company applies theprovisions of SEC Staff Accounting Bulletin (“SAB”) No. 104, “RevenueRecognition” for the sale of non-software products.  SAB No. 104 which supercedes SAB No. 101, “RevenueRecognition in Financial Statements”, provides guidance on the recognition,presentation and disclosure of revenue in financial statements.  SAB No. 104 outlines the basic criteria thatmust be met to recognize revenue and provides guidance for the disclosure ofrevenue recognition policies.  Ingeneral, the Company recognizes revenue related to product sales when (i)persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii)the fee is fixed or determinable, and (iv) collectibility is reasonablyassured.

 

Revenue recognition isdeferred when undelivered products or services are essential to thefunctionality of delivered products, customer acceptance is uncertain,significant obligations remain, or the fair value of undelivered elements isunknown.

 

7

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Software revenue

 

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

 

The Company recognizes revenuein accordance with the provisions of Statement of Position 97-2 (“SOP 97-2”), “SoftwareRevenue Recognition”, as amended by Statement of Position 98-9 (“SOP 98-9”), “Modificationof SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions”.  Under the provisions of SOP 97-2, 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 softwaresales are generally multiple element arrangements, which could include theproduct, first year annual maintenance and support, and training andinstallation.  Revenues from the multipleelements arrangements are allocated to each element based on the relative fairvalue of the elements.  If the fair valueof the element 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 each elementdoes 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 delivered 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 arederived mainly from maintenance and support contracts and are recognized on astraight-line basis over the term of the contract. Payments for maintenance andsupport revenues are normally received in advance and are nonrefundable. 

 

*Accounts Receivable and Allowance for Doubtful Accounts:*

 

Accounts receivable are recorded at the invoiced amount and do not bearinterest. The allowance for doubtful accounts is the Company’s best estimate ofthe amount of probable credit losses in its existing accounts receivable. TheCompany determines the allowance based on historical write-off experience andcustomer economic data. The Company reviews the allowance for doubtful accountsmonthly. Past due balances over 60 days and over a specified amount arereviewed individually for collectibility. Account balances are charged offagainst the allowance when the Company believes that it is probable thereceivable will not be recovered. The Company does not have anyoff-balance-sheet credit exposure related to its customers.

 

8

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**Note 2 –****Variable Interest Entity**

 

**In October 2003, theCompany entered into a Secured Loan Agreement with Prostate Centers of America(“PCA”).  Under the agreement, theCompany is obligated to make periodic advances subject to PCA achieving certainmilestones.  The secured note bearsinterest at 6% per annum and is repayable in four installments commencing on December 1,2004, with all unpaid principal and interest due on September 1, 2005.**

** **

**As of July 31, 2004,the Company’s advances to PCA totaled $700,000, with an obligation, contingentupon certain milestones, to advance an additional $500,000. The Company has noequity interest in PCA.**

** **

**The funds are to be usedfor general working capital to provide various brachytherapy services toambulatory surgical centers. A distributor who has agreed to procure all of itsbrachytherapy seeds exclusively from the Company for a period of five years hasa 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 beneficiary under Financial Accounting StandardsBoard Interpretation No. 46, “Consolidation of Variable InterestEntities—an interpretation of ARB No. 51” (“FIN No. 46”). FINNo. 46 is effective for a VIE created after January 31, 2003 and to aVIE in which an enterprise obtains an interest after that date.**

 

9

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**The Company has determinedthat PCA is a VIE since it does not have sufficient equity at risk for theentity to finance its activities. FIN No. 46 requires that an enterpriseconsolidate a VIE if that enterprise has a variable interest that will absorb amajority of the entity’s expected losses if they occur. Accordingly, theCompany adopted FIN No. 46 in October 2003 and consolidated PCA as aVIE, regardless of the Company not having an equity interest in PCA and itscreditors having no recourse against the Company.**

** **

**Consolidation of the PCAas of July 31, 2004, and October 31, 2003 resulted in theconsolidation of cash of $148,000 and $350,000, respectively, which is held byPCA.  The consolidated balance sheet of July 31,2004 also included $103,000 in accounts receivable, $493,000 of equipment andleasehold improvements, and $732,000 of accounts payable and accrued expensesfrom PCA.  Consolidation of PCA’s resultsof operations for the three and nine months ended July 31, 2004 resultedin a net loss of $418,000 and $656,000, respectively.**

** **

**Note 3 –Marketable Securities**

** **

**The Company invests excess cash inmarketable securities consisting primarily of commercial paper, corporate notesand bonds, U.S. Government securities and money market funds.**

** **

**Debt securities that the Companyhas the positive intent and ability to hold to maturity are classified as “held-to-maturity”and reported at amortized cost.**

** **

**The Company continually reviews itsinvestments to determine whether a decline in fair value below the cost basisis other than temporary. If a decline in fair value is judged to be other thantemporary, the cost basis of the security is written down to fair value and theamount of the write-down is included in the Consolidated Statements ofOperations.**

** **

**Note 4 - AccountsReceivable**

** **

Accounts receivableconsist of the following: 

 
| ** **                            | ** ** | **July 31,  2004** | ** ** | **October 31,  2003** | ** ** |
|---------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Accounts  receivable – Trade     |       | $                       | 6,919,000  |                       | $          | 2,270,000 |   |
| Less: allowance for doubtful accounts |       | (147,000                | )          | (103,000                   | )          |
|                                  |       | $                       | 6,772,000  |                       | $          | 2,167,000 |   |

 

Provision for doubtful accounts was $25,000 and none for the threemonths ended July 31, 2004 and 2003, respectively, and $44,000 and $17,000, forthe nine months ended July 31, 2004 and 2003, respectively.

 

**Note 5 –Inventories**

** **

**Inventories are valued at the lowerof cost or market as determined under the first-in, first-out method. Costsinclude materials, labor and manufacturing overhead. Inventories are shown netof applicable reserves and allowances. Inventories consist of the following:**

** **
| ** **      | ** ** | **July 31,  2004** | ** ** | **October 31,  2003** | ** ** |
|-----------------|------------|-------------------------|------------|----------------------------|------------|
| Raw  materials  |       | $                       | 5,982,000  |                       | $          | 639,000 |   |
| Work in process |       | 85,000                  |       | 25,000                     |       |
| Finished goods  |       | 462,000                 |       | 28,000                     |       |
|            |       | $                       | 6,529,000  |                       | $          | 692,000 |   |

 

10

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**Note 6 –Intangible Assets**

** **

Intangible assets consistof the following: 

 
| ** **                     | ** ** | **July 31,  2004** | ** ** | **October 31,  2003** | ** ** |
|--------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Customer  relationships        |       | $                       | 1,052,000  |                       | $          | 52,000 |   |
| Trade names                    |       | 7,726,000               |       | 26,000                     |       |
| Technology                     |       | 19,033,000              |       | 233,000                    |       |
| Licenses and patents           |       | 98,000                  |       | 592,000                    |       |
|                           |       | 27,909,000              |       | 903,000                    |       |
| Less: accumulated amortization |       | (483,000                | )          | (90,000                    | )          |
|                           |       | $                       | 27,426,000 |                       | $          | 813,000 |   |

 

**Amortization expense was $434,000and $8,000 for the three months ended July 31, 2004 and 2003, and $467,000and $20,000 for the nine months ended July 31, 2004, and 2003,respectively. See Note 8 for a discussion of the intangible assetsacquired in the NOMOS acquisition and Note 10 for a discussion of theimpairment of certain intangible assets.**

** **

**Note 7 – Net Lossper Share**

** **

Basic earnings (loss) pershare is computed by dividing the net income (loss) by the weighted averagenumber of shares outstanding for the period. Diluted earnings (loss) per shareis computed by dividing the net income (loss) by the sum of the weightedaverage number of common shares outstanding for the period plus the assumedexercise of all dilutive securities by applying the treasury stock methodunless such assumed exercises are anti-dilutive. The following table sets forththe computation of basic and diluted earnings (loss) per share:

 
| ** **                                     | ** ** | **Three months ended July 31,** | ** **  | **Nine months ended July 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|-------------|-------------------------------------|------------|
| ** **                                     | ** ** | **2004**                             | ** **  | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                           |       |                                 |        |                                |       |   |   |   |   |
| Net loss                                       |       | $                                    | (19,446,000 | )                                   | $          | (2,837,000 | ) | $ | (27,286,000 | ) | $ | (6,289,000 | ) |
| Weighted average shares outstanding - basic    |       | 15,679,214                           |        | 10,259,002                          |       | 12,193,057 |   | 10,252,661 |   |
| Dilutive effect of stock options and  warrants |       | —                               |        | —                              |       | — |   | — |   |
| Weighted average shares outstanding  -diluted  |       | 15,679,214                           |        | 10,259,002                          |       | 12,193,057 |   | 10,252,661 |   |
| Basic loss per share                           |       | $                                    | (1.24       | )                                   | $          | (0.28 | ) | $ | (2.24 | ) | $ | (0.61 | ) |
| Diluted loss per share                         |       | $                                    | (1.24       | )                                   | $          | (0.28 | ) | $ | (2.24 | ) | $ | (0.61 | ) |

 

Stock options andwarrants to purchase 3,485,081 and 2,317,897 common shares for the three monthsended July 31, 2004, and 2003, respectively, and 3,793,649 and 2,308,096common shares for the nine months ended July 31, 2004 and 2003,respectively, were not included in the computation of diluted earnings pershare because their effect would have been anti-dilutive.

 

11

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**Note 8 –Acquisition of NOMOS**

 

On May 4, 2004, the Company acquired NOMOS Corporation (“NOMOS”).  The results of NOMOS have been included inthe consolidated financial statements from the date of acquisition. NOMOSdevelops, markets and sells medical devices used in external beam radiation. Asa result of the acquisition, the Company expects to benefit from a furtherdiversified and expanded product line in the radiation oncology medical deviceindustry.  

 

The purchase price of approximately $58 millionoriginally consisted of $12 million in cash, the issuance of 5.3 million sharesof the Company’s common stock with a fair value of approximately $38 million,the assumption of 1.4 million of stock options and warrants with a fair valueof $4.6 million, direct transaction costs of $3.0 million and the assumption ofacquisition related liabilities of $0.4 million.  The fair value of thecommon stock used in determining the purchase price was $7.21 per share basedon the average of the closing price of the common stock for the period two daysbefore and after the October 27, 2003 merger agreement announcement date.The stock options and warrants, which fully vested at the acquisition date,were valued using a Black-Scholes valuation model with the followingassumptions: risk-free interest rate of 4.5%, volatility factor of 60%,expected term of 1.5 years for stock options, contractual term of0.5 years for warrants and no dividend yield. The acquisition wasaccomplished through a reverse triangular merger into a wholly owned subsidiaryof the Company, and is reflected in the Company’s financial statements,including the footnotes thereto, as the IMRT/IGRT operating segment.

 

Pursuant to the purchaseagreement, approximately 15.8% of the shares of common stock and cash otherwisepayable to the NOMOS shareholders were deposited into two separate escrowfunds. With respect to the first escrow fund, 526,810 shares of the Company’scommon stock and $1.2 million of cash will be held for a period of two yearsfollowing the acquisition date, as a source of reimbursement for losses arisingfrom any breach by NOMOS of its representations or obligations under thepurchase agreement. With respect to the second escrow fund, 307,617 shares ofthe Company’s common stock and $0.7 million of cash were held in escrow as asource of reimbursement for any losses incurred in connection with the demandmade against NOMOS by Parker/Hunter Incorporated (“Parker/Hunter”).  The Company settled the Parker/Hunter matterin August 2004 for $1.1 million (See Note 11). As a result of the settlement, cash of $0.5 million and 89,026 shares ofcommon stock were returned to the Company and 218,591 shares of common stockand $0.2 million of cash will be distributed to the NOMOS selling shareholdersfrom the escrow fund during the quarter ended October 31, 2004. As a result ofthe settlement of the Parker/Hunter matter, the original purchase price hasbeen adjusted to reflect a decrease of $0.5 million in cash, a reduction of theissuance of 89,026 shares, and an increase of $1.1 million in the assumption ofacquisition related liabilities.

 

The purchase price has been allocated based on the estimated fairvalues of the assets acquired and liabilities assumed as of the date ofacquisition as follows: 

 
| Cash                                    |   | $          | 1,771,000  |   |
|-----------------------------------------|--------|------------|------------|--------|
| Accounts receivable                     |   | 2,908,000  |       |
| Inventories                             |   | 4,593,000  |       |
| Equipment and leasehold improvements    |   | 1,423,000  |       |
| In-process research and development     |   | 7,800,000  |       |
| Acquired identifiable intangible assets |   | 27,500,000 |       |
| Goodwill                                |   | 22,725,000 |       |
| Other current and long term assets      |   | 508,000    |       |
| Accounts payable                        |   | (2,097,000 | )          |
| Accrued expenses                        |   | (3,271,000 | )          |
| Deferred revenue                        |   | (5,879,000 | )          |
| Total                                   |   | $          | 57,981,000 |   |

 

The amount allocated to in-process research and development (“IPR&D”)represents an estimate of the fair value of purchased in-process technology forresearch projects that as of the acquisition date, will not have reachedtechnological feasibility and have no alternative future use. Only thoseresearch projects that had advanced to a stage of development where managementbelieved reasonable net future cash flow forecasts could be prepared and areasonable likelihood of technical success existed were included in theestimated fair value. The estimated fair value of the IPR&D to be acquiredin the merger was determined based on applying a 20% discount rate to theforecast of the estimated net future cash flows for each project, adjusted forthe estimated probability of technical success for each research project.IPR&D was expensed during the three months ended July 31, 2004.Ongoing research and development projects are generally focused on developingenhancements and adding features and functionality that allow existing productsto more effectively and efficiently treat cancers found in disease sites, suchas liver and breast, for which our products, due to certain design limitations,have traditionally not been used. Strategically, this should enable the Companyto expand the market for its products rather than to

 

12

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simply maintain the existing revenue base. Significant investment inresearch and development has been, and will continue to be, necessary toenhance existing products, develop new products and to allow the combinedcompany to generate new product sales to further penetrate and expandgeographic markets for its products. 

 

The value assigned toIPR&D was comprised of the following projects: BAT® with optical tracking, which wasreleased in the three months ended July 31, 2004 ($6.4 million),development of a significantly enhanced treatment planning system which isexpected to be released in fiscal 2005 ($0.6 million), and a treatmentplanning product, which is expected to incorporate enhanced technology withMonte Carlo based simulation capabilities which is expected to be released infiscal 2006 ($0.5 million), and other smaller projects($0.3 million). Each product development has a risk of failure or delay inintroduction that could result in diminished overall cash flows should theproduct not be introduced to the market as currently anticipated. Continuedproduct innovation and timely release of IPR&D projects, once integratedand redefined as necessary, are believed to be fundamental to the success ofthe combined company. 

 

The amounts allocated toIPR&D, and other intangible assets for financial reporting purposes willnot result in future income tax deductions since the acquisition is expected tobe a nontaxable transaction. The deferred taxliabilities related to such temporary differences were offset by deferred taxassets (primarily net operating loss carryforwards subject to change inownership provisions of Internal Revenue Service Code Section 382) in thepurchase price allocation. The Company provided a full valuation allowanceagainst the remaining net deferred tax assets since realization cannot besufficiently assured. The Company intends to file consolidated and combinedfederal and state income tax returns with NOMOS. Goodwill is not deductible forincome tax purposes. Accordingly, no provision or benefit for income taxes wererecognized in the accompanying pro forma results of operations. 

 

The acquired identifiableintangible assets will be amortized over their useful lives as follows: 

 
| ** **                      | ** ** | **Amount** | ** ** | **Useful Lives (in years)** | ** **                  |
|---------------------------------|------------|------------|------------|-----------------------------|-----------------------------|
| Purchased technology            |       | $          | 18,800,000 |                        | 12 – no residual value |   |
| Existing customer relationships |       | 1,000,000  |       | 10 – no residual value |                        |
| Trademark                       |       | 7,700,000  |       | Indefinite                  |                        |
| Total                           |       | $          | 27,500,000 |                        |                        |   |

 

The following tablepresents unaudited pro forma revenue, net loss and loss per share giving theeffect of NOMOS acquisition as if it had been completed at the beginning ofeach period presented:

 
| ** **                                             | ** ** | **Three months ended July 31,** | ** ** | **Nine months ended July 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                             | ** ** | **2004**                             | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                   |       |                                 |       |                                |       |   |   |   |   |
| Revenue                                                |       | $                                    | 8,137,000  |                                | $          | 10,508,000 |   | $ | 29,221,000 |   | $ | 34,737,000 |   |
| Loss before cumulative effect of accounting  change(1) |       | (10,590,000                          | )          | (3,646,000                          | )          | (23,195,000 | ) | (6,016,000 | ) |
| Net loss(1)                                            |       | (10,590,000                          | )          | (3,646,000                          | )          | (23,195,000 | ) | (6,327,000 | ) |
| Net loss per share, basic and diluted(1)               |       | (0.68                                | )          | (0.23                               | )          | (1.47 | ) | (0.41 | ) |
|                                                        |            |                                      |            |                                     |            |  |  |  |  |  |  |  |  |

 

----

(1) Excludes a $7.8million charge for IPR&D and $1.1 million in merger and integration costsassociated with the acquisition of NOMOS.

 

13

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The unaudited pro forma financial information above reflects theCompany’s changes in revenue recognition policy. Prior to the acquisition bythe Company on May 4, 2004, NOMOS had recognized revenue of the BAT® productunder SAB 101 as a product in which software was deemed incidental. The Companyhas determined that revenue recognition of the BAT® product should be accountedfor under SOP 97-2. The Company also determined that the timing of revenuerecognition of the BAT® product should be deferred from the time of shipment,as NOMOS 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 resultspresented for the three and nine months ended July 31, 2004. The impact of thechange in revenue recognition for the periods presented on revenues was anincrease of $0.6 million for the three months ended July 31, 2003, and anincrease of $1.8 million and $0.5 million for the nine months ended July 31,2004 and 2003, respectively. The impact of the change in revenue recognitionfor the periods presented on net loss was a decrease in net loss of $0.2million for the three months ended July 31, 2003 and a decrease in net loss of$1.0 million and $0.3 million for the nine months ended July 31, 2004 and 2003,respectively. As a result of the Company’s decision to change the revenuerecognition of the BAT® product, the financial information presented in Forms8-K/A dated July 19, 2004, should no longer be relied upon.

 

**Note 9 – SegmentInformation**

** **

**The Company’s operationsare divided into three segments based upon a combination of factors including:product produced, manufacturing process and management oversight.  The Company’s three segments are: IMRT/IGRT,Radiation Sources, and Theseus. IMRT/IGRT develops and markets products usedduring external beam radiation therapy for the treatment of cancer.  Radiation Sources develops and marketsradioisotopic products including brachytherapy seeds and accessories used inthe treatment of cancer and non-therapeutic products used in medical,environmental, research and industrial applications.  Theseus has been developing aradiopharmaceutical imaging agent for various medical diagnostic and monitoringfunctions, including the management of chemotherapy treatment.  However, in August 2004, the Companyelected to discontinue operating Theseus, effective on or about September 15,2004 (Note 10).**

** **

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

** **

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

** **
| ** **                | ** ** | **Three months ended July 31,** | ** **  | **Nine months ended July 31,** | ** ** |
|---------------------------|------------|--------------------------------------|-------------|-------------------------------------|------------|
| ** **                | ** ** | **2004**                             | ** **  | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues**              |       |                                 |        |                                |       |   |   |   |   |
|                      |       |                                 |        |                                |       |   |   |   |   |
| IMRT/IGRT                 |       | $                                    | 4,977,000   |                                | $          | — |   | $ | 4,977,000 |   | $ | — |   |
| Radiation Sources         |       | 3,160,000                            |        | 3,011,000                           |       | 10,005,000 |   | 11,056,000 |   |
| Theseus                   |       | —                               |        | —                              |       | — |   | — |   |
|                      |       | $                                    | 8,137,000   |                                | $          | 3,011,000 |   | $ | 14,982,000 |   | $ | 11,056,000 |   |
|                      |       |                                 |        |                                |       |   |   |   |   |
| **Loss from  Operations** |       |                                 |        |                                |       |   |   |   |   |
|                      |       |                                 |        |                                |       |   |   |   |   |
| IMRT/IGRT                 |       | $                                    | (10,499,000 | )                                   | $          | — |   | $ | (10,499,000 | ) | $ | — |   |
| Radiation Sources         |       | (2,639,000                           | )           | (1,238,000                          | )          | (6,726,000 | ) | (1,600,000 | ) |
| Theseus                   |       | (6,422,000                           | )           | (1,849,000                          | )          | (10,550,000 | ) | (5,912,000 | ) |
|                      |       | $                                    | (19,560,000 | )                                   | $          | (3,087,000 | ) | $ | (27,775,000 | ) | $ | (7,512,000 | ) |

 

14

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| ** **        | ** ** | **July 31,  2004** | ** ** | **October 31,  2003** | ** ** |
|-------------------|------------|-------------------------|------------|----------------------------|------------|
| **Goodwill**      |       |                    |       |                       |       |
|              |       |                    |       |                       |       |
| IMRT/IGRT         |       | $                       | 22,725,000 |                       | $          | — |   |
| Radiation Sources |       | 207,000                 |       | 207,000                    |       |
| Theseus           |       | —                  |       | 3,659,000                  |       |
| Total  goodwill   |       | $                       | 22,932,000 |                       | $          | 3,866,000 |   |
|              |       |                    |       |                       |       |
| **Total Assets**  |       |                    |       |                       |       |
|              |       |                    |       |                       |       |
| IMRT/IGRT         |       | $                       | 63,588,000 |                       | $          | — |   |
| Radiation Sources |       | 30,467,000              |       | 57,790,000                 |       |
| Theseus           |       | 45,000                  |       | 4,742,000                  |       |
| Total  assets     |       | $                       | 94,100,000 |                       | $          | 62,532,000 |   |

 

**Note 10 –Impairment of Goodwill and Long-lived Assets**

 

**During the quarter ended July 31,2004, the Company determined that it needed to review the carrying value of itsTheseus assets for possible impairment due to ongoing discussions with variousthird parties concerning strategic alternatives for the Hynic-Annexin V productdevelopment program.  Discussions withvarious financing and potential strategic partners ceased in August 2004which resulted in the Company’s decision to discontinue the operations ofTheseus in September 2004.  TheCompany determined that the carrying value of its assets exceeded their fairvalue and therefore recorded a $4.7 million charge for the impairment ofgoodwill and long-lived assets of Theseus during the three months ended July 31,2004. Fair value was determined based on estimated future cash flows.**

** **

**The Company expects toincur additional costs of up to $1.1 million in severance, license terminationfees and facility shut-down costs during the quarter ended October 31,2004.**

** **

**The impairment of goodwilland long-lived assets consisted of the following:**

** **
| Goodwill                             |   | $       | 3,659,000 |   |
|--------------------------------------|--------|---------|-----------|--------|
| Licenses and patents                 |   | 481,000 |      |
| Equipment and leasehold improvements |   | 541,000 |      |
| Total                                |   | $       | 4,681,000 |   |

** **

**Note 11 -Litigation**

** **

In March 2004, Parker/Hunter filed a complaint against NOMOS,alleging breach by NOMOS of an investment banking fee arrangement.  NOMOS filed an answer denying all substantiveallegations of liability.  

 

15

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In May 2004, NOMOS became a wholly-owned subsidiary of the Company (SeeNote 8).  The Company accrued a liabilityof $1.1 million for the claim.  In August 2004,the Company paid Parker/Hunter $1.1 million in settlement of all claims relatedto its complaint filed against NOMOS.

 

As part of the Company’sagreement and plan of merger with NOMOS, the Company placed into escrow 307,617shares of common stock and $0.7 million cash of the NOMOS purchaseconsideration to cover the anticipated settlement costs of the Parker/Hunterlitigation. In October 2004, the Company received reimbursement in fullfor the costs of the Parker/Hunter settlement from the escrowed funds in theform of 89,026 shares and cash of $0.5 million. The remaining $0.2 million ofcash and 218,591 shares of common stock will be distributed to the NOMOSselling shareholders.

 

16

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**Item2.   Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

The following discussion and analysis provides information, which ourmanagement believes is relevant to an assessment and understanding of ourfinancial condition and results of operations. The discussion should be read inconjunction with the Consolidated Financial Statements contained herein and thenotes thereto. Certain statements contained in this Form 10-Q, including,without limitation, statements containing the words “believes”, “anticipates”, “estimates”,“expects”, “projections”, and words of similar import are forward looking asthat term is defined by: (i) the Private Securities Litigation Reform Actof 1995 (the “1995 Act”) and (ii) releases issued by the Securities and ExchangeCommission (“SEC”). These statements are being made pursuant to the provisionsof the 1995 Act and with the intention of obtaining the benefits of the “SafeHarbor” provisions of the 1995 Act. We caution that any forward lookingstatements made herein are not guarantees of future performance and that actualresults may differ materially from those in such forward looking statements asa result of various factors, including, but not limited to, any risks detailedherein or detailed from time to time in our other filings with the SECincluding our most recent report on Form 10-K. We are not undertaking anyobligation to update publicly any forward-looking statements. Readers shouldnot place undue reliance on these forward-looking statements.

 

**Overview**

** **

We manufacture, marketand sell products for the radiation oncology community, including brachytherapyseeds and ancillary devices used primarily in the treatment of prostate cancer,as well as intensity modulated and image guidance radiation therapy productsand services for localization and treatment of cancer.  Our business is organized into threeoperating segments: IMRT/IGRT, Radiation Sources, and Theseus. Theseus wasdiscontinued in September 2004 and had been developing radiopharmaceuticalagents for various medical diagnostic and monitoring functions, including themanagement of chemotherapy treatment.  

 

IMRT/IGRT develops andmarkets intensity modulated radiation therapy (“IMRT”) and image guidedradiation therapy (“IGRT”) products used in external beam radiation therapy forthe treatment of cancer. Radiation Sources develops and markets radioisotopicproducts including brachytherapy seeds, accessories and calibration sourcesused in the treatment of cancer and in medical, environmental, research andindustrial applications.

 

From 1998 to January 2003,our brachytherapy seeds were distributed under an exclusive agreement with adistributor.  In January 2003, theagreement terminated and we began to market and sell our brachytherapy productsdirectly to health care providers. Future revenues and gross profit relating to our brachytherapy productswill depend on several factors, including our ability to successfully directlymarket and distribute our brachytherapy products, to withstand pricing pressurefrom competition, and to successfully enter in agreements with group purchasingorganizations.

 

On May 4, 2004, we acquiredNOMOS Corporation (“NOMOS”). NOMOS was a privately held developer,manufacturer, and marketer of IMRT and IGRT products and services.  This acquisition will significantly expandour product offerings to radiation oncologists. Under the terms of the agreement and plan of merger we paidapproximately $58 million, originally consisting of $12.0 million in cash, theissuance of 5.3 million shares of the Company’s common stock with a fair valueof approximately $38 million, the assumption of 1.4 million of stock optionsand warrants with a fair value of $4.6 million, direct transaction costs of$3.0 million and the assumption of acquisition related liabilities of $0.4million.  Pursuant to the purchaseagreement, approximately 15.8% of the shares and of common stock and cashotherwise payable to NOMOS shareholders was deposited into escrow accounts as asource of reimbursement for losses arising from breach by NOMOS of itswarranties under the purchase agreement and for losses incurred in theParker/Hunter matter.  As a result of thesettlement of the Parker/Hunter matter in August 2004, the purchase price hasbeen adjusted to reflect a decrease of $0.5 million in cash, a reduction of 0.1million shares, and an increase of $1.1 million in the assumption ofacquisition related liabilities.  Wemanage this business as our IMRT/IGRT operating segment.

 

 

17

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Since we acquired Theseus in October 2000, it has incurred over$30 million in operating losses, and the projected expenditures in thedevelopment of Hynic-Annexin V are expected to have a continuedsignificant negative impact on our earnings and cash flow.  We believe that successful completion andreceipt of required regulatory approvals allowing marketing would not occurearlier than 2007, and additional related costs could be at least $50 million. During the quarter ended July 31,2004, we determined that we needed to review the carrying value of the Theseusassets for possible impairment due to ongoing discussions with various thirdparties concerning strategic alternatives for the Hynic-Annexin V productdevelopment program.  We determined thatthe carrying value of the Theseus assets at July 31, 2004 exceeded theirfair value and therefore recorded a $4.7 million charge for the impairmentof goodwill and long-lived assets of Theseus during the three months ended July 31,2004.  Discussions with various financingand potential strategic partners ceased in August 2004, and on August 27,2004 our board of directors unanimously adopted management’s recommendations tocease operations at Theseus in September 2004.  We expect to incur additional costs of up to $1.1 millionin severance, license termination fees and facility shut-down costs for Theseusduring the quarter ended October 31, 2004.

** **

**Results of Operations**

** **

**Third Quarter ofFiscal 2004 Compared to Third Quarter of Fiscal 2003**

** **

**Net sales**. Net sales increased $5.1 million, or 170%, to $8.1 million for the threemonths ended July 31, 2004, from $3.0 million for the three months ended July 31,2003.  The increase in sales during thequarter ended July 31, 2004, is primarily attributed to the acquisition ofNOMOS (our IMRT/IGRT business) in May 2004 ($5.0 million) and the acquisitionof Radiation Therapy Products (“RTP”) in August of 2003 ($0.1million).  Our net sales reflect thedecision to adopt the revenue recognition policy under SOP 97-2 with respect tosales of our BAT® products whereby sales are recognized upon product acceptanceby the customers rather than at the time of shipment. The IMRT/IGRT revenue of$5.0 million for the third quarter, 2004 represented a $2.5 million, or 34%, declinefrom the same period last year.  Thedecrease in revenue is attributable to the transition effect of the integratingof the Radiation Source and IMRT/IGRT sales force, during the three monthsended July 31, 2004.

 

**Gross profit**.  Gross profit increased $2.1 million, or 161%,to $3.3 million for the three months ended July 31, 2004, from $1.3million for the three months ended July 31, 2003.  Gross profit as a percentage of salesdecreased from 42% to 41% during this period. Gross profit during the three months ended July 31, 2004 consistedof $2.0 million or 40% of sales from IMRT/IGRT and $1.3 million or 43% of salesfrom Radiation Sources.  The increase ingross profit and the decrease in gross profit as percentage of sales were bothattributable to our IMRT/IGRT business acquired in May 2004. Gross profit as apercent of sales may vary due to changes in the mix of IMRT/IGRT and RadiationSources products sold.

 

**Selling Expense**.  Selling expenses increased $1.4 million, or156% to $2.3 million for the three months ended July 31, 2004, from $0.9million for the three months ended July 31, 2003.  The increase in selling expense is primarilyattributed to the acquisition of our IMRT/IGRT business in May 2004.

 

**General and administrativeexpenses**.  General andadministrative (“G&A”) expenses increased $2.0 million, or 110%, to $3.8million for the three months ended July 31, 2004, from $1.8 million forthe three months ended July 31, 2003. The increase is primarily attributedto the acquisition of our IMRT/IGRT business in May 2004 ($0.9 million), theinclusion of personnel costs and professional fees associated with ProstateCenters of America (“PCA”) ($0.5 million) as further described in Note 2, andan increase in accounting, legal and insurance costs ($0.4 million).

 

**Research and development**.  Research and development (“R&D”) expensesincreased $1.6 million, or 97%, to $3.3 million for the three months ended July 31,2004, from $1.7 million for the three months ended July 31, 2003.  The increase is primarily attributed to theacquisition of our IMRT/IGRT business in May 2004 ($1.8 million), offset by adecrease in costs of our Hynic-Annexin V program. 

 

**In-process research anddevelopment**.  Duringthe three months ended July 31, 2004, we incurred a charge of $7.8 millionfor in-process research and development (“IPR&D”) related to theacquisition of our IMRT/IGRT business (See Note 8).

 

**Impairment of goodwill and long-lived assets.**  Since we acquired Theseus in October 2000,it has incurred over $30 million in operating losses, and the projectedexpenditures in the development of Hynic-Annexin V are expected to have acontinued significant negative impact on our earnings and cash flow.  We believe that successful completion andreceipt of required regulatory approvals allowing marketing will not occurearlier than 2007, and additional related costs could be at least $50million.  As a result, during the quarterended July 31, 2004, we determined that we needed to review the carryingvalue of the Theseus assets for possible impairment due to ongoing discussionswith various third parties concerning strategic alternatives for theHynic-Annexin V product development program.  We determined that the carrying value of theTheseus assets exceeded their fair value and therefore recorded a$4.7 million charge for the impairment of goodwill and long-lived assetsof Theseus during the three months ended July 31, 2004.  Discussions with various financing andpotential strategic partners ceased in August 2004 which resulted in ourdecision to discontinue the operations of Theseus in September 2004.  We expect to incur additional costs of up to $1.1 millionin severance, license termination fees and facility shut-down costs for Theseusduring the quarter ended October 31, 2004.

 

**Merger and integration costs**.  During the three months ended July 31,2004, we incurred merger and integration charges of $1.1 million in connectionwith the acquisition of our IMRT/IGRT business. The charge includes severanceand consulting costs.

 

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**Interest and other income, net.**  Interest and other income decreased $136,000,or 54%, to $114,000 for the three months ended July 31, 2004, from$250,000 for the three months ended July 31, 2003. The decrease isattributed to smaller portfolio of marketable securities.

 

**Provision for Income Taxes**.  We did not recognize a tax benefit forresults of operations for the three months ended July 31, 2004 and 2003,due to the uncertainty of our ability to fully recognize the benefit of ourdeferred tax assets.

 

**Nine Months Ended July 31,2004 Compared to Nine Months Ended July 31, 2003**

** **

**Net sales**. Net sales increased $3.9 million, or 36%, to $15.0 million for the ninemonths ended July 31, 2004, from $11.1 million for the nine months ended July 31,2003.  The increase in net sales isprimarily attributed to our IMRT/IGRT business acquired in May 2004 ($5.0million) and the acquisition of RTP in August of 2003 ($0.3 million),offset by a decrease in our other Radiation Sources business ($1.4million).  The decrease in RadiationSources is due to a decline in unit volume that we attribute to our transitionfrom selling our brachytherapy products through an exclusive third partydistributor, which relationship terminated in January 2003, to sellingthem directly to our customers in February 2003.  Our net sales reflect the decision to adoptthe revenue recognition policy under SOP 97-2 with respect to sales of our BAT®(B-Mode Acquisition and Targeting System) products whereby sales are recognizedupon product acceptance by the customers rather than at the time of shipment.  The IMRT/IGRT proforma revenue for the ninemonths ended July 31, 2004 was $17.0 million and represented a $6.7million, or 28%, decline from the proforma revenue in the same period lastyear. The decrease in revenue is attributable to the transition effect ofintegrating the Radiation Source and IMRT/IGRT sales forces during the ninemonths ended July 31, 2004.

 

**Gross profit.**  Gross profit increased $0.2 million, or 5%,to $6.3 million for the nine months ended July 31, 2004, from $6.1 millionfor the nine months ended July 31, 2003. Gross profit as a percent of sales decreased from 55% to 42% during thisperiod.  The increase in gross profit isprimarily attributed to the acquisition of our IMRT/IGRT business in May 2004($2.0 million), offset by a decrease in gross profit from the sale of RadiationSources ($1.7 million). The decrease in gross profit as a percentage of salesis due to both the lower margin on IMRT/IGRT (40% of sales) and a lower grossprofit margin in Radiation Sources (43% of sales).  The decrease in gross profit dollars and as apercentage of sales of Radiation Sources was primarily due to reduced economiesof scale due to a reduction in brachytherapy unit volume and an increase in thevolume of lower margin ancillary services. This decline in unit volume is attributed to our transition from sellingthrough a distributor to selling direct during the second fiscal quarter of2003. Gross profit as a percent of sales may vary due to changes in the mix ofIMRT/IGRT and Radiation Sources products sold.

 

**Selling Expenses.**  Selling expenses increased $1.4 million, or59% to $3.9 million for the nine months ended July 31, 2004, from $2.5million for the nine months ended July 31, 2003. The increase isattributable to sales and marketing costs of our IMRT/IGRT business acquired inMay 2004.

 

**General and administrativeexpenses**.  G&Aexpenses increased $3.9 million, or 69% to $9.6 million for the nine monthsended July 31, 2004, from $5.7 million for the nine months ended July 31,2003.  The increase is attributed to ourbusiness segments as follows: $0.9 million attributed to the acquisition of ourIMRT/IGRT, $2.7 million to Radiation Sources and $0.3 million to Theseus. Theincrease in G&A attributable to Radiation Sources is due primarily toseverance and non-cash stock compensation expense associated with theresignation of our former chief financial officer ($1.0 million), the inclusionof expenses associated with PCA ($0.7 million), an increase in personnel costs($0.9 million), and accounting, legal and insurance costs ($0.4 million).

 

**Research and development.**  R&D expenses increased $1.7 million, or30%, to $7.1 million for the nine months ended July 31, 2004, from $5.4million for the nine months ended July 31, 2003.  The increase is primarily attributed to ourIMRT/IGRT business acquired in May 2004.

 

**In-process research anddevelopment**.  Duringthe nine months ended July 31, 2004, we incurred a charge of $7.8 millionfor in-process research and development (“IPR&D”) related to theacquisition of our IMRT/IGRT business (See Note 8).

 

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**Impairment of goodwill and long-lived assets.**  Since we acquired Theseus in October 2000,it has incurred over $30 million in operating losses, and the projectedexpenditures in the development of Hynic-Annexin V are expected to have acontinued significant negative impact on our earnings and cash flow.  We believe that successful completion andreceipt of required regulatory approvals allowing marketing will not occurearlier than 2007, and additional related costs could be at least $50 million.  As a result, during the quarter ended July 31,2004, we determined that we needed to review the carrying value of the Theseusassets for possible impairment due to ongoing discussions with various thirdparties concerning strategic alternatives for the Hynic-Annexin V productdevelopment program.  Discussions withvarious financing and potential strategic partners ceased in August 2004which resulted in our decision to discontinue the operations of Theseus in September 2004.  We determined that the carrying value of theTheseus assets exceeded their fair value and therefore recorded a $4.7 millioncharge for the impairment of goodwill and long-lived assets of Theseus duringthe three months ended July 31, 2004.  We determined fair value based on estimatedfuture cash flows.  In addition, weexpect to incur additional costs of up to $1.1 million in severance, licensetermination fees and facility shut-down costs for Theseus during the quarterended October 31, 2004.

 

**Merger and integration costs**.  During the nine months ended July 31,2004, we incurred merger and integration costs of $1.1 million in connectionwith the acquisition of our IMRT/IGRT business. The charge includes severanceand consulting costs.

 

**Interest and other income**.  Interest and other income decreased $1.0million, or 68%, to $0.5 million for the nine months ended July 31, 2004,from $1.5 million for the nine months ended July 31, 2003. The decrease ininterest and other income reflects a one-time gain of $0.6 million from thesale of our remaining shares of RadioMed Corporation, a privately held company,which occurred during the nine months ended July 31, 2003, and lowerinterest income as a result of a general decline in our available marketablesecurities.  

 

**Provision for Income Taxes**.  We did not recognize a tax benefit forresults of operations for the nine months ended July 31, 2004 and 2003,due to the uncertainty of our ability to fully recognize the benefit of ourdeferred tax assets.

 

**Cumulative effect of change inaccounting principle**.  During the nine months ended July 31,2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,”for recording future decommissioning costs related to our leased manufacturingand research facilities.  Under SFAS No. 143, a future retirementobligation is recorded at present value by discounting the Company’s estimatedfuture asset retirement obligation.  In adopting this pronouncement, werecognized a charge of $0.3 million which is reported in the caption “Cumulativeeffect of change in accounting principle.”

 

**Critical Accounting Policies**

** **

The preparation offinancial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make judgments, assumptions and estimates that affect the amountsreported in the Consolidated Financial Statements. Note 1 to the ConsolidatedFinancial Statements included in the Company’s Form 10-K for the year ended October 31,2003, describes 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.

 

*RevenueRecognition*

* *

We sell products for theradiation oncology community, including brachytherapy seeds used in thetreatment of cancer, as well as intensity modulated radiation therapy (“IMRT”)and image guidance radiation therapy (“IGRT”) products and services.  Product revenue consists of brachytherapy andrelated products sales.  Softwarerevenues consist of IMRT and IGRT product sales.

 

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Product revenue

 

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

 

Revenue recognition isdeferred when undelivered products or services are essential to thefunctionality of delivered products, customer acceptance is uncertain,significant obligations remain, or the fair value of undelivered elements isunknown.

 

Software revenue

 

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

 

We recognize revenue inaccordance with the provisions of Statement of Position 97-2 (“SOP 97-2”), “SoftwareRevenue Recognition”, as amended by Statement of Position 98-9 (“SOP 98-9”), “Modificationof SOP 97-2, Software Revenue Recognition, with respect to Certain Transactions”.  Under the provisions of SOP 97-2, werecognize 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 we are notinvolved in providing services that are essential to the functionality of theproduct.

 

Our software sales aregenerally multiple element arrangements, which could include the product, firstyear annual maintenance and support, and training and installation.  Revenues from the multiple elementarrangements 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 each elementdoes 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 delivered 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

 

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

 

*Accounts Receivable and Allowance for Doubtful Accounts:*

 

Accounts receivable are recorded at the invoiced amount and do not bearinterest. The allowance for doubtful accounts is the our best estimate of theamount of probable credit losses in our existing accounts receivable. Wedetermine the allowance based on historical write-off experience and customereconomic data. We review our allowance for doubtful accounts monthly. Past duebalances over 60 days and over a specified amount are reviewed individually forcollectibility. Account balances are charged off against the allowance when webelieve that it is probable the receivable will not be recovered. We do nothave any off-balance-sheet credit exposure related to our customers.

 

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*Goodwill*

* *

Our methodology forallocating the purchase price related to purchase acquisitions is determinedthrough established valuation techniques. Goodwill is measured as the excess of the cost of the acquisition overthe amounts assigned to identifiable assets acquired less assumedliabilities.  We perform goodwillimpairment tests on an annual basis and between annual tests in certaincircumstances. In response to changes in industry and market conditions, we maystrategically realign our resources and consider restructuring, disposing of,or otherwise exiting businesses, which could result in an impairment of goodwill.

 

*Impairmentof Long-lived Assets*

* *

We assess the impairmentof long-lived assets, which include equipment and leasehold improvements andidentifiable intangible assets, whenever events and circumstances indicate thatsuch assets might be impaired.  In the eventthe expected undiscounted future cash flow attributable to the asset is lessthan the carrying amount of the asset, an impairment loss equal to the excessof the asset’s carrying value over its fair value is recorded.  

 

*LossContingencies*

* *

We record liabilitiesrelated to pending litigation when an unfavorable outcome is probable and wecan reasonably estimate the amount of the loss. We are subject to various legal proceedings and claims, either assertedor unasserted, that arise in the ordinary course of business. We evaluate,among other factors, the degree of probability of an unfavorable outcome and anestimate of the amount of the loss. Significant judgment is required in boththe determination of the probability and as to whether an exposure can bereasonably estimated. When we determine that it is probable that a loss hasbeen incurred and the amount can be reasonably estimated, 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 incometaxes using the liability method. Deferred taxes are determined based on thedifferences between the financial statement and tax bases of assets andliabilities, using enacted tax rates in effect for the year in which thedifferences are expected to reverse. Valuation allowances are established whennecessary to reduce deferred tax assets to the amounts expected to berealized.  In addition, we are subject toexamination of our income tax returns by the Internal Revenue Service and othertax authorities.  We regularly assess thelikelihood of adverse outcomes resulting from these examinations.

 

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**Liquidity and CapitalResources**

** **

To date, our short-termliquidity needs have generally consisted of operating capital to finance growthin inventories, trade accounts receivable, new product research anddevelopment, capital expenditures, acquisitions and strategic investments inrelated businesses.  We have satisfiedthese needs primarily through a combination of cash generated by operations,public offerings and from private placements of our common stock.  We do not currently have a line of credit orsimilar arrangement with a bank. Although we continue to believe that existingcash resources and the cash generated by operations and investments will be sufficientto support our operations and planned expansion for at least the next twelvemonths, we are investigating other forms of financing, including a line ofcredit with a bank.

 

Based on the Company’scurrent operating plans, management believes existing cash resources and cashforecasted by management to be generated by operations will be sufficient tomeet working capital and capital requirements through at least the next twelvemonths.  Also, management’s plans to attain profitability and generate additionalcash flows include increasing revenues from existing and new products andservices, realizing the benefits of the integration of NASI and NOMOSoperations and a focus on cost control.  There is no assurance thatmanagement will be successful with these plans.  However, if events andcircumstances occur such that the Company does not meet its current operatingplan as expected, and the Company is unable to raise additional financing, theCompany may be required to further reduce certain discretionary spending, whichcould have a material adverse effect on the Company’s ability to achieve itsintended business objectives.

 

The following sectionsdiscuss the effects of changes in our balance sheets, cash flows, andcommitments on our liquidity and capital resources.

 

**Balance Sheet and Cash Flows**

** **

Cash, cash equivalents,and investments in marketable securities.  At July 31, 2004, we had cash and cashequivalents, and investments in marketable securities aggregating approximately$23.1 million, a decrease of approximately $26.0 million from $49.1 million at October 31,2003. The decrease was primarily attributed to net cash payments of $13.2million for the acquisition of NOMOS, $15.1 million used in operatingactivities, and $1.3 million used for capital expenditures, partially offset by$3.6 million in cash received from the exercise of stock options and theemployee stock purchase plan.  The $15.1million of cash used in operating activities included $5.7 million used inTheseus operations, $5.3 million used in Radiation Sources operations and $1.2million used in IMRT/IGRT operations, all described above in the Results ofOperations for the nine months ended July 31, 2004.  In addition, cash was used to fund increasesin accounts receivable ($1.7 million) and inventory ($1.2 million).

 

We expect that cash usedin operating activities may fluctuate in future periods as a result of a numberof factors, including fluctuations in our operating results, accountsreceivable collections, inventory management, research and developmentexpenses, the impact of the NOMOS integration and the timing of payments. 

 

During the quarter ended July 31,2004, we received $3.6 million from the exercise of stock options and thepurchase of shares related to our employee stock purchase plan.  Proceeds from the exercise of stock optionsand the employee stock purchase plan will vary from period to period basedupon, among other factors, fluctuations in the market value of our stockrelative to the exercise price of such options.

 

The primary objectivesfor our investment portfolio are liquidity and safety of principal.  Investments are made to achieve the highestrate of return, consistent with these two objectives.  We invest excess cash in securities withvarying maturities to meet projected cash needs.

 

Equipment and leaseholdimprovements. Equipment and leasehold improvements (“Fixed Assets”) increasedapproximately $1.3 million to $4.3 million at July 31, 2004, from $3.0million at October 31, 2003.  Theincrease in Fixed Assets reflects capital expenditures of $1.2 million and theacquisition of NOMOS equipment and leasehold improvements of $1.4 millionoffset by $0.8 million in depreciation expense and a write down for impairmentof $0.5 million (See Note 10).  Includedin the $1.2 million of capital expenditures are $0.5 million in equipment andleasehold improvements of PCA.

 

Other assets.  At July 31, 2004, other assets wereapproximately $0.1 million, a decrease of approximately $1.2 million from $1.3million at October 31, 2003.  Thedecrease in other assets was due to the reclassification of capitalizedtransaction costs of the NOMOS acquisition as part of the purchase priceallocation (See Note 8).  

 

Accounts payable andaccrued expenses. Accounts payable and accrued expenses increased approximately $6.5million to $13.3 million as of July 31, 2004, from $6.8 million at October 31,2003. The increase was a result of an assumption of liabilities as part of thepurchase price allocation associated with the NOMOS acquisition (See Note 8).

 

Deferred revenue.  Deferred revenue increased approximately $5.8million from October 31, 2003 to July 31, 2004. The increase wasattributable to our IMRT/IGRT business acquired in May 2004.  Deferred

 

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revenue consists of unearned service revenue and from the deferral ofsoftware product revenue where customer acceptance has not been received or fornew products where acceptance by our customers has not been clearlyestablished.

 

**Liquidity andCapital Resource Requirements**

** **

We have operating leaseobligations for facilities and equipment under non-cancelable operating leaseagreements. Future minimum lease payments are subject to annual adjustment forincreases in the Consumer Price Index. We have also entered into contractual arrangements with third partiesfor (i) services associated with our Hynic-Annexin V development program, (ii)services related to the acquisition of NOMOS, (iii) contingent obligations toPCA, and (iv) commitments to suppliers under blanket purchase orders.  

 
| ** **                   | ** ** | **Payments by Due Date** | ** ** |
|------------------------------|------------|--------------------------|------------|
| **Contractual  Obligations** | ** ** | **Total**                | ** ** | **Less than 1  year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
|                         |       |                     |       |   |   |   |   |   |   |   |   |
| Operating leases             |       | $                        | 4,913,000  |   | $ | 1,038,000 |   | $ | 636,000 |   | $ | 1,476,000 |   | $ | 1,763,000 |   |
| Theseus commitments          |       | 560,000                  |       | 560,000 |   | — |   | — |   | — |   |
| Purchase commitments         |       | 1,930,000                |       | 1,930,000 |   |   |   |   |   |   |   |
|                         |       | $                        | 7,400,000  |   | $ | 3,528,000 |   | $ | 636,000 |   | $ | 1,476,000 |   | $ | 1,763,000 |   |

 

On August 27, 2004,our board of directors unanimously adopted management’s recommendation to ceaseoperations at Theseus on or about September 15, 2004.  As a result of this decision, we plan toredirect capital resources that would have been invested in Theseus towards thedevelopment of other product lines and working capital requirements of ourIMRT/IGRT and Radiation Sources businesses.

 

However, the amount of capital that we will need in the future willdepend on many factors including:

 

•      Levels of sales and marketing that will berequired to launch future products and achieve and maintain a competitiveposition in the marketplace for both existing and new products;

 

•      Market acceptance of our products;

 

•      Levels of inventory and accounts receivablethat we maintain;

 

•      Competitors’ responses to our products;

 

•      Level of capital expenditures; and

 

•      Acquisition or development of otherbusinesses, technologies or products.

 

If we should require additional financing due to unanticipateddevelopments, additional financing may not be available when needed or, if available,we may not be able to obtain this financing on terms favorable to ourstockholders or us.  Insufficient fundsmay require us to delay, scale back or eliminate

 

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some or all of our research and development programs.  If additional funds are raised by issuingequity securities, dilution to existing stockholders would result.

 

**Recent AccountingPronouncements**

** **

In December 2003,the SEC issued SAB No. 104.  SAB No. 104 revises or rescinds portions of theinterpretive guidance included in Topic 13 of the codification of staffaccounting bulletins in order to make this interpretive guidance consistentwith current authoritative accounting and auditing guidance and SEC rules andregulations.  It also rescinds the Revenue Recognition in FinancialStatements Frequently Asked Questions and Answers document issued inconjunction with Topic 13.  Selected portions of that document have beenincorporated into Topic 13.  The adoption of SAB No. 104 did not have a materialimpact on our financial position, results of operations or cash flows.

 

In July 2004, the Emerging Issues Task Force (“EITF”) published its consensus on Issue No.  03-01, “The Meaning of Other Than-Temporary Impairment and Its Application to Certain Investments.”  EITF Issue No. 03-01 addresses the meaning of  other-than-temporary  impairment and its application to debt and equity  securities within the scope of SFAS No. 115,  certain debt and equity  securities  within  the  scope  of  SFAS  No.  124,  and  equity securities  that are not  subject  to the scope of SFAS No. 115 and not accounted for under the equity method of accounting.  In September 2004, the FASB issued FASB Staff Position  (“FSP”)  Emerging Issues Task Force (“EITF”) Issue 03-1-1, which  delays the  effective  date for the  recognition  and measurement  guidance in EITF Issue No. 03-1. In addition,  the FASB has issued a proposed FSP to consider whether further  application  guidance is necessary for securities analyzed for impairment under EITF Issue No. 03-1.  We continue  to assess the  potential  impact that the adoption of the proposed FSP could have on our financial statements.

 

###### **Item 3.    Quantitative and Qualitative Disclosuresabout Market Risk**

###### ** **

Information about market risks for the three months ended July 31,2004, does not differ materially from that discussed under Item 7A of ourAnnual Report on Form 10-K for the fiscal year ended October 31, 2003.

 

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

###### ** **

(a)  Evaluation of Disclosure Controls andProcedures 

 

As required byRule 13a-15(b) under the Securities and Exchange Act of 1934 (the “ExchangeAct”), we have carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer (“CEO”)and our Chief Financial Officer (“CFO”), of the effectiveness, as of the end ofthe fiscal quarter covered by this report, of the design and operation of our “disclosurecontrols and procedures” as defined in Rule 13a-15(e) promulgated by theSEC under the Exchange Act. Based upon that evaluation, our CEO and our CFOconcluded that our disclosure controls and procedures, as of the end of suchfiscal quarter, were adequate and effective to ensure that information requiredto be disclosed by us in the reports that we file or submit under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the Commission’s rules and forms. 

 

(b)  Changes in Internal Controls 

 

There have been nosignificant changes in our internal controls over financial reporting or inother factors that could significantly affect our internal controls overfinancial reporting subsequent to the date of the evaluation referred to above.

 

**PART II –OTHER INFORMATION**

 

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

** **

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

###### ** **

On May 3, 2004, we held aspecial meeting of stockholders to vote on (i). the approval of the agreementand plan of merger, by and among the Company, AM Capital I, Inc., and NOMOS(the “Merger Agreement”)and the issuance of shares of the Company’s commonstock under the Merger Agreement and other transactions contemplated by theMerger Agreement (“NOMOS Acquisition”); (ii). the approval of an amendment tothe Amended and Restated 1996 Stock Option Plan to permit the issuance ofreplacement stock options in connection with the merger or consolidation (“ReplacementOptions”); and (iii). the approval of an amendment to the Amended and Restated1996 Stock Option Plan to increase the maximum number of shares available underthe plan from 4.0 million shares to 4.6 million shares (“Increase Shares of1996 Option Plan”).  The results of thevotes were as follows:

 
| **Proposal**                        | ** ** | **For**   | ** ** | **Withheld** | ** ** | **Abstained** | ** ** |
|-------------------------------------|------------|-----------|------------|--------------|------------|---------------|------------|
| NOMOS Acquisition                   |       | 7,149,174 |       | 558,813      |       | 6,551         |       |
|                                |       |      |       |         |       |          |       |
| Replacement Options                 |       | 6,624,178 |       | 1,082,772    |       | 7,512         |       |
|                                |       |      |       |         |       |          |       |
| Increase Shares of 1996 Option Plan |       | 3,959,555 |       | 3,744,540    |       | 10,367        |       |

 

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On June 4, 2004, we held our 2004 Annual Meeting ofStockholders.  The following persons wereelected as directors to hold office until the 2005 Annual Meeting ofShareholders: Irwin J. Gruverman, L. Michael Cutrer, Donald N. Ecker, Dr.Jonathan P. Gertler, John A. Friede, Mitchell H. Saranow, Dr. Gary N. Wilner,John W. Manzetti and Nancy J. Wysenski. The number of shares cast for, withheldand abstained with respect to each of the nominees were as follows:

 
| **Nominee**             | ** ** | **For**   | ** ** | **Withheld** | ** ** | **Abstained** | ** ** |
|-------------------------|------------|-----------|------------|--------------|------------|---------------|------------|
| Irwin J. Gruverman      |       | 9,418,322 |       | 561,291      |       | —        |       |
| L. Michael Cutrer       |       | 9,421,422 |       | 558,191      |       | —        |       |
| Donald N. Ecker         |       | 9,869,007 |       | 110,606      |       | —        |       |
| Dr. Jonathan P. Gertler |       | 9,888,207 |       | 91,406       |       | —        |       |
| John A. Friede          |       | 9,420,822 |       | 558,791      |       | —        |       |
| Mitchell H. Saranow     |       | 9,342,073 |       | 637,540      |       | —        |       |
| Dr. Gary N. Wilner      |       | 9,342,073 |       | 637,540      |       | —        |       |
| John W. Manzetti        |       | 9,421,822 |       | 557,791      |       | —        |       |
| Nancy J. Wysenski       |       | 9,886,007 |       | 93,606       |       | —        |       |

 

The stockholders also voted to approve the ratification of theselection of PricewaterhouseCoopers LLP as our independent accountants for thefiscal year ended October 31, 2004. A total of 6,874,301 shares were for the adoption of the proposal,3,031,752 were cast against the proposal, and 73,560 shares were abstained.

 

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

 

 
|                  | NORTH AMERICAN  SCIENTIFIC, INC. |
|-----------------------|----------------------------------|
|                  |                             |
|                  |                             |   |
| January 27, 2005 | By:                              | /s/ L. Michael Cutrer |   |
|                  |                             | Name: | L. Michael Cutrer |
|                  |                             | Title: | President and  Chief Executive Officer |
|                  |                             |   | (Principal Executive Officer) |
|                  |                             |   |   |
|                  |                             |   |
| January 27, 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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