UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10-K


(Mark
One)


[X]
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the Fiscal Year Ended August 31,
2008





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





For
the Transition Period From _____ to _____





Commission
File Number:  001-32526


BSD
MEDICAL CORPORATION


(Exact
name of registrant as specified in its charter)


Delaware
            75-1590407(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)





2188
      West 2200 South, Salt Lake City, Utah
            84119(Address
      of principal executive office)
            (Zip
      Code)





Registrant's
telephone number, including area code:  (801) 972-5555





Securities
registered pursuant to Section 12(b) of the Act:


Title of Each
      Class
            Name of Each Exchange
      on which RegisteredCommon
      Stock, Par Value $0.001
            The
      NASDAQ Stock Market LLC





Securities registered pursuant to
Section 12(g) of the Act:None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes
[  ] No[X]





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes
[  ] No[X]





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





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [  ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):





Large
      accelerated filer [  ]
            Accelerated
      filer [X]Non-accelerated
      filer [  ] (Do not check if a smaller reporting
    company)
            Smaller
      reporting company [X]





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





The
aggregate market value of the common stock held by non-affiliates of the
registrant as of February 29, 2008 was approximately $60,252,000.





As of
November 10, 2008, the registrant had 21,819,342 shares of its common stock, par
value $.001, outstanding.





Documents
Incorporated by Reference:  Portions of the definitive Proxy Statement
to be delivered to shareholders in connection with the 2009 Annual Meeting of
Shareholders, which is expected to be held February 4, 2009, are incorporated by
reference into Part III hereof.








BSD MEDICAL CORPORATION


FORM
10-K





For
the Year Ended August 31, 2008





TABLE
OF CONTENTS








Part IItem
      1.
            Business
            3Item
      1A
            Risk Factors
            17Item
      1B
            Unresolved Staff Comments
            21Item
      2.
            Properties
            21Item
      3.
            Legal Proceedings
            21Item
      4.
            Submission of Matters to a Vote of Security
      Holders
            21Part IIItem
      5.
            Market
      for the Registrant’s Common Equity, Related Stockholder Matters andIssuer
      Purchases of Equity Securities
            22Item
      6.
            Selected Financial Data
            23Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results ofOperations
            24Item
      7A.
            Quantitative and Qualitative Disclosure About Market
      Risk
            33Item
      8.
            Financial Statements and Supplementary
    Data
            34Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and
      FinancialDisclosure
            34Item
      9A.
            Controls and Procedures
            34Item
      9B.
            Other Information
            36Part IIIItem
      10.
            Directors, Executive Officers and Corporate
      Governance
            36Item
      11.
            Executive Compensation
            36Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and
      RelatedStockholder Matters
            36Item
      13.
            Certain Relationships and Related Transactions, and Director
      Independence
            36Item
      14.
            Principal Accountant Fees and Services
            36Part IVItem
      15.
            Exhibits and Financial Statement
Schedules
            37Signatures
            39





2


PART
I





ITEM
1.   BUSINESS





Overview




BSD
Medical Corporation develops, manufactures, markets and services medical systems
that deliver precision-focused radio frequency (RF) or microwave energy into
diseased sites of the body, heating them to specified temperatures as required
by a variety of medical therapies.  Our business objectives are to
commercialize our products developed for the treatment of cancer and to further
expand our developments to treat other diseases and medical
conditions.  Our product line for cancer therapy has been created to
offer hospitals and clinics a complete solution for thermal treatment of cancer
as provided through microwave/RF systems.  We consider our operations
to comprise one business segment.




While our
primary developments to date have been cancer treatment systems, we also
pioneered the use of microwave thermal therapy for the treatment of symptoms
associated with enlarged prostate, and we are responsible for much of the
technology that has successfully created a substantial new medical industry
addressing the needs of men’s health.  In accordance with our
strategic plan, we subsequently sold our interest in TherMatrx, Inc., the
company established to commercialize our technology to treat enlarged prostate
symptoms, to provide substantial funding that we can utilize for commercializing
our systems used in the treatment of cancer and in achieving other business
objectives.




In spite
of the advances in cancer treatment technology, nearly 40% of cancer patients
continue to die from the disease in the United
States.  Commercialization of our systems used to treat cancer is our
most immediate business objective.  Our BSD-2000 and BSD-500 cancer
treatment systems are used to treat cancer with heat while boosting the
effectiveness of radiation through a number of biological
mechanisms.  Our MicroThermX-100 Microwave Ablation System is used to
ablate soft tissue with heat alone.  Current and targeted cancer
treatment sites for our systems include cancers of the prostate, breast, head,
neck, bladder, cervix, colon/rectum, esophagus, liver, brain, bone, stomach and
lung.  Our cancer treatment systems have been used to treat thousands
of patients throughout the world, and have received much notoriety, including
the Frost & Sullivan “Technology Innovation of the Year Award” for cancer
therapy devices awarded for the development of the BSD-2000.
  Our
BSD-2000 systems are used to non-invasively treat cancers located deeper in the
body, and are designed to be companions to the estimated 7,500 linear
accelerators used to treat cancer through radiation and in combination with
chemotherapy treatments.  Our BSD-500 systems treat cancers on or near
the body surface and those that can be approached through body orifices such as
the throat, the rectum, etc., or through interstitial treatment in combination
with interstitial radiation (brachytherapy).  BSD-500 systems can be
used as companions to our BSD-2000 systems and the estimated 2,500 brachytherapy
systems installed.


Based on
our management team’s knowledge of the market, we believe that the fully
saturated potential market for these developed cancer therapy systems is in
excess of $5 billion.  We also project an after-market opportunity
based on service agreements that equates to approximately 15% of the purchase
price of our systems per year.  We believe that the replacement cycle
for our systems, based on advances in software, hardware and other components,
will average 5-7 years. Our financial model in the higher production environment
of established commercial sales is to achieve a 60% gross margin on systems and
an 80% gross margin on service agreements and disposable applicators used with
our MicroThermX-100 system.




Return to Table of Contents
 3




We have
received United States Food and Drug Administration, or FDA, approval to market
our commercial version of the BSD-500, and in March 2006, we completed a
submission for FDA approval to sell the BSD-2000 in the United
States.  In August 2007, we successfully concluded a pre-approval and
quality system inspection by the FDA.  In December 2007, we received a
letter from the FDA denying our application for pre-market approval of the BSD
2000 and providing guidance regarding amendments needed to make the BSD-2000
submission approvable.  We have subsequently met with the FDA to
clarify its requirements and are currently seeking to satisfy these
requirements.  In April 2008, we submitted a 510(k) premarket
notification to the FDA for the MicroThermX-100 system, and in September 2008 we
received FDA clearance to market the MicroThermX-100 thermal ablation system in
the United States.  We have designed our cancer therapy systems such
that together they are capable of providing treatment for most solid tumors
located virtually anywhere in the body.




Although
we have not entered these markets, we also believe that our technology has
application for a number of other medical purposes in addition to
cancer.


On April
22, 2008 we changed the listing of our stock from the American Stock Exchange
(AMEX) to the NASDAQ Stock Market (NASDAQ), and our stock now trades under the
NASDAQ symbol “BSDM.”




The Sale of
TherMatrx




One of
our important contributions to the advancement of medical therapy has been our
pioneering work in developing a new treatment for conditions associated with
enlargement of the prostate that afflicts most men as they age.  As
the prostate enlarges it constricts urine flow.  The condition is
known medically as benign prostatic hyperplasia or BPH.  We developed
a technology that allows men to be treated for BPH through an outpatient
procedure as an alternative to surgery or a lengthy regimen of
medication.




We
determined early in our planning that we would treat our development of BPH
therapy as a spin-off business with the intent of providing funding for our
primary business objectives.  As a result, we introduced the
opportunity to investment groups and subsequently on October 31, 1997 entered
into an agreement with investors Oracle Strategic Partners, L. P. and Charles
Manker.  Together we established a new company, TherMatrx, Inc.
TherMatrx received capital from these investors to conduct clinical trials, and
after obtaining FDA approval in July 2001, the funding to commercialize the
development.  We were compensated for providing manufacturing,
regulatory and engineering support to assure the success of the new
company.




On July
15, 2004, TherMatrx, Inc. was sold to American Medical Systems Holdings, Inc.
(AMS).  Our part of the total proceeds from this sale was
approximately 25%.  A portion of the payout from the sale was based on
contingency payments.  By the close of fiscal 2006, we had concluded
the receipt of contingency payments from the TherMatrx sale; the payout to us,
including contingency payments, being approximately $33.5 million.  In
April 2007, the Company received an additional $202,223 in proceeds from the
sale of TherMatrx.




Return to Table of Contents
 4


Our Contributions to Cancer
Therapy




Despite
the massive attention given to cancer prevention and treatment, the American
Cancer Society estimates that 1,437,180 new cancer cases will be diagnosed and
that 565,650 Americans will die from cancer during 2008.  In the
United States the chance of developing cancer during a person’s lifetime is one
in two for men and one in three for women.  Cancer develops when
abnormal cells in a part of the body begin to grow out of control and spread to
other parts of the body.




Our
cancer treatment systems have been developed to both kill cancer directly with
heat and to increase the effectiveness of the primary cancer treatment used with
it.  The primary cancer therapies currently used include:




·
            Radiation
      therapy, which is treatment with high-energy rays to kill or shrink cancer
      cells. The radiation may come from outside of the body (external
      radiation) or from radioactive materials placed directly in a tumor
      (internal or implant radiation, sometimes called
      brachytherapy).·
            Chemotherapy,
      which is treatment with drugs to destroy cancer cells.·
            Surgery,
      which is the resection, or removal, of a tumor or organ of the
      body.




Some
cancers, such as certain cancers of the liver, prostate, bone metastases and
even lung cancer, can be killed using heat alone.   For these
treatments we have developed the MicroThermX-100 thermal ablation system that is
used to ablate soft tissues at high temperatures as a stand-alone
therapy.




The
treatment of many cancers is generally prescribed with one or more of the
primary cancer therapies noted above. Because cancer remains a leading cause of
death, these three cancer therapies are still grossly inadequate, and an
enormous need for better treatment is obvious.  We have engineered
systems designed to increase the effectiveness of these cancer treatments
through the use of precision-focused RF/microwave energy to selectively heat
cancer, creating “hyperthermia” in cancerous tumors.  Hyperthermia is
an emerging cancer therapy that both kills cancer cells directly and has been
shown to be a potent additive treatment in making certain of the major existing
cancer therapies more effective for some cancers.




Hyperthermia
therapy has been shown to substantially improve the results from cancer
treatments for a variety of tumors. Completed randomized clinical trials in
which the effectiveness of radiation therapy combined with hyperthermia therapy
was compared with the results of radiation therapy alone in cancer treatment
produced the following results:  For melanoma, after two years, local
control (local regression or disappearance of the tumor) was 28% for the control
group of patients who received radiation therapy alone versus 46% local control
for the patients who received both hyperthermia and radiation
therapy.  For recurrent breast cancer, the complete response rate
(complete disappearance of the tumor) increased from 38% for those receiving
radiation therapy alone to 60% for those patients who received both hyperthermia
and radiation therapy.  For glioblastoma (brain cancer), the two-year
survival rate for patients who received radiation therapy alone was 15%,
compared to 31% survival rate two years after treatment for those who received
both hyperthermia and radiation therapy.  For advanced cervical
cancer, the complete response rate (disappearance of the tumor) rose from 57%
for patients who received radiation treatments alone to 83% for patients
receiving both hyperthermia and radiation therapy.  The cervical
cancer data was based on the condition of patients three years after
treatment.




Cancerous
tumors are uncontrolled growths of mutated cells that require more energy to
survive than do cells of normal tissue.  As cancer cells grow rapidly,
they tend to outstrip their blood supply, leaving them oxygen-starved, since
there is not enough blood to carry sufficient oxygen to these
cells.  Oxygen-starved cancer cells are resistant to radiation therapy
because the destructive power of radiation therapy depends heavily on tearing
apart the oxygen molecules located in cancer cells.  When oxygen
molecules are torn apart, they form oxygen radicals that can attack cancer cell
DNA.  Blood depletion also makes cancer resistant to chemotherapy,
where blood transport is required to deliver the drug into the
tumor.  Our hyperthermia therapy systems precisely deliver microwave
energy to elevate the temperature of tumors, usually between 40°C and 45°C
(104°F to 113°F).  The elevated temperatures draw blood to the tumor
as the body’s natural response to the stimulus of heat.  The increased
blood supply to the tumor improves delivery of drugs to tumors in
chemotherapy.  It also delivers more oxygen to the tumor, increasing
the effectiveness of radiation therapy.




Return to Table of Contents
 5




While
sensitizing tumors for more effective treatment from radiation and/or
chemotherapy, hyperthermia also destroys cancer cells directly through damage to
the plasma membrane, the cytoskeleton and the cell nucleus, and by disrupting
the stability of cellular proteins.  Tumors with poor blood supply
systems lack the natural cooling capacity provided by efficient blood flow in
normal tissues, making them selectively susceptible to the cancer-destructive
effects of hyperthermia therapy.




Hyperthermia
has other therapeutic uses.  It can be used to shrink tumors prior to
surgery, potentially making resection easier or even
possible.  Research has shown hyperthermia to be an activator for gene
therapies by speeding gene production (heat mediated gene
therapy).  Hyperthermia may play a role in the development of new
anti-tumor vaccines that are based on the production of heat shock
proteins.  Research has shown hyperthermia to be an angiogenesis
inhibitor, which means it helps prevent cancer from inducing growth of new blood
vessels to expand its blood supply.  Hyperthermia could also become a
follow-up therapy for other angiogenesis inhibitors, used in the final
destruction of cancer cells depleted of blood by angiogenesis inhibitor
therapy.  Hyperthermia has been shown to improve a patient’s quality
of life.  Even in situations where there is no hope for survival,
hyperthermia may provide benefits through alleviation of such effects of cancer
as bleeding, pain and infection.




Since the
founding of the Company, we have been heavily involved in developing
technological advances to expand the use of hyperthermia therapy for the
treatment of cancer.  Our efforts have included joint work with many
notable cancer research centers in the United States and Europe.  In
past years, funding for our research efforts has been provided by such sources
as the National Institutes of Health in the United States and major European
government agencies.  In recent years, we have focused our efforts in
perfecting the technology required to precisely deliver deep, non-invasive
hyperthermia therapy for the treatment of pelvic and other deep cancers and to
demonstrate effective use of deep hyperthermia through clinical
trials.  We believe that our BSD-2000 system has emerged from this
development effort as the world’s most advanced system for hyperthermia
therapy.




We have
developed various technologies for heating cancerous tumors, depending on their
location in the body.  Through our developments, cancers such as
melanomas or recurrent breast cancer located near the surface of the body can be
treated with superficial cancer treatment applicators and
systems.  Cancers that can be accessed through natural body orifices,
or that are accessible through catheters inserted into the tumor as part of
invasive radiation techniques (such as used to treat prostate cancer or head and
neck cancer) can be treated with tiny, inserted antennae that we have developed
to deliver focused microwave energy into the cancerous tissue.  We
have also developed systems to non-invasively treat cancers located deep in the
body by focusing electromagnetic energy on the cancer through a cylindrical
applicator that surrounds the body.  This cylindrical applicator
contains an array of multiple antennae that focus radio frequency energy, and
therefore heat, on the tumor.  Temperature levels for treatments are
monitored through small temperature sensors, and some of our systems can be
interfaced with magnetic resonance imaging, or MRI, so that the treatment in
progress can be observed, and temperatures can be monitored through images
colorized to depict gradation of temperature levels (thermography).




Our
BSD-500 is used to treat cancers located near the surface of the body, or areas
that can be accessed using inserted antennae.  The BSD-500 comes in
several versions, depending on the customer requirements.  The
BSD-2000 is used to non-invasively treat deep cancers.  This system
also comes in several versions, including models with three dimensional, or 3D,
steering of electromagnetic energy, as well as the ability to be integrated with
MRI.




Return to Table of Contents
 6




The
BSD-500 has received FDA approval.  In addition, the system has gone
through an extensive revision, and has obtained two major FDA supplements to
this approval that have been necessary to allow its commercial
introduction.




The
BSD-2000 does not currently have FDA approval except as an investigational
device; however, the phase III clinical trial that we have used to apply for the
FDA approval has been concluded and published in a major
journal.  Formal submission for FDA approval of the BSD-2000 was made
in March 2006.  We sought and obtained regulatory approval for the
sale of the BSD-2000 in the People’s Republic of China during
2005.




The
MicroThermX-100 thermal ablation system received FDA marketing clearance in
September 2008.




Most of
our sales of cancer therapy systems over recent past periods have been to cancer
research institutions for use in conducting clinical trials with our
equipment.  As a company, we are now in the early stages of marketing
the new commercial version of the BSD-500 and the
MicroThermX-100.  Obtaining FDA approval for the BSD-2000 would
greatly contribute to our sales efforts by providing the additional technology
required for the treatment of solid tumors located virtually anywhere in the
body.




Our Products and
Services




We have
developed the technology and products required to approach thermal ablation and
hyperthermia cancer therapy through multiple techniques, which collectively
allow cancer to be treated virtually anywhere in the body:




·
            Thermal
      ablation ablates soft tissues at high temperatures through focused
      microwave energy.·
            Superficial
      hyperthermia non-invasively treats cancerous tumors located within a few
      centimeters of the surface of the body, such as melanoma and recurrent
      breast cancer.·
            Internal
      or interstitial hyperthermia treats tumors in combination with internal
      radiation therapy by inserting tiny microwave antennae that deliver
      hyperthermic microwave energy to tumors through the same catheters used to
      deliver radioactive materials, or “seeds,” to tumors for radiation
      therapy.  This technique can be employed in treating prostate
      cancer, breast cancer, head and neck cancer and a variety of other cancer
      sites.·
            Deep
      hyperthermia non-invasively treats tumors located deep within the body,
      including many problematic cancer sites located in the pelvis, abdomen and
      chest areas.




MicroThermX-100.  Our
MicroThermX-100 Microwave Ablation System has been developed to ablate soft
tissue percutaneously, laparoscopically or surgically.  The
MicroThermX-100 utilizes precision-guided microwave energy to ablate soft
tissue.  The MicroThermX-100 includes a computer driven control
system, temperature sensors and a disposable applicator.  The advanced
features and capabilities of the MicroThermX-100 were made possible by our years
of research, design and development in the discipline of thermal medicine
technology, supported by leading research centers throughout the world (see
reference to these in the section for the BSD-2000).  Disposable
applicators for the MicroThermX-100 are especially designed according to the
method by which they will be used in treatment, whether by surgeons or
interventional radiologists.


Return to Table of Contents
 7




BSD-500
Systems.  Our BSD-500 systems are used to deliver either
superficial or interstitial hyperthermia therapy or both.  There are
four configurations of the BSD-500.  The BSD-500i-4 and BSD-500i-8
provide interstitial hyperthermia treatment using four or eight channel
generators, respectively.  Each channel can control three interstitial
applicators.  The BSD-500c-4 and BSD-500c-8 provide both superficial
and interstitial hyperthermia treatments using four or eight channel
generators.  These systems include a touch screen display monitor by
which the operator controls the hyperthermia treatment, computer equipment and
software that controls the delivery of microwave energy to the tumor, and a
generator that creates the needed microwave energy for the
treatment.  Additionally, the systems include a variety of
applicators, depending on each system configuration.  Non-invasive
superficial applicators are used for superficial hyperthermia
treatments.  For interstitial hyperthermia treatments, the system may
include up to 24 tiny microwave heat-delivering antennae that are inserted into
catheters used in the standard practice for internal radiation therapy (called
brachytherapy).




We have
received FDA approval through FDA supplements for implementation of a new
operating system and other commercial upgrades, allowing us to commercially
introduce this new family of four systems. Our primary FDA approval (described
as a pre-market approval, or PMA, the standard FDA approval required to market
Class III medical devices in the United States) for the BSD-500 family of
systems is applicable to the marketing of all four configurations of the BSD-500
in the United States.  We have also certified the BSD-500 systems for
the CE Mark, which is required for export into some European
countries.




BSD-2000.  The
BSD-2000 family of products includes the BSD-2000, the BSD-2000/3D and the
BSD-2000/3D/MR. These systems non-invasively deliver hyperthermic microwave
energy to cancerous tumors, including those located deep within the
body.  These systems include a computer and software that control the
delivery of microwave energy to the tumor, a microwave energy amplifier that
boosts the microwave power, and a special applicator that delivers the microwave
energy to the patient lying in a prone position on a specially designed support
table.  The BSD-2000 systems are able to direct, focus and deliver
microwave energy deep within the body by precisely “steering” the energy to the
tumor from a cylindrical array of antennae.  The basic BSD-2000 has
eight microwave antennae enabling this electronic steering of energy within the
patient’s body.  The BSD-2000/3D has 24 microwave antennae enabling
additional electronic steering along the long axis of the body.  The
3D steering is particularly useful when implemented with a magnetic resonance
system that is capable of non-invasive 3D imaging showing the heated regions,
thus permitting the 3D steering to more accurately target the energy to the
tumor site.


The
BSD-2000 systems have not yet received pre-market approval from the FDA for
commercial marketing in the United States, but the BSD-2000 has obtained an
investigational device exemption, or IDE, for sale in the United States for
research purposes only.  We have also certified the BSD-2000 family
for the CE Mark required for export into certain European countries and have
obtained regulatory approval for the sale of the BSD-2000 in the People’s
Republic of China.  We are engaged in the extensive process of
supporting the review of an FDA submission requesting a PMA for the BSD-2000
based on clinical data we have already obtained.  While we believe
that this data has great merit and is worthy of submission, due to the inherent
uncertainties of the FDA approval process there can be no assurance that FDA
approval will be obtained through our submissions.




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 8


Development
of the BSD-2000, the BSD-2000/3D and the BSD-2000/3D/MR has required substantial
effort involving the cooperative work of such American research institutions as
Duke University, Northwestern University, University of Southern California,
Stanford University, University of Utah and University of Washington St.
Louis.  Contributing European research institutions include Daniel den
Hoed Cancer Center of the Academisch Ziekenhuis (Rotterdam, Netherlands),
Haukeland University Hospital (Bergen, Norway), Dusseldorf University Medical
School, Tübingen University Medical School, Essen University Hospital, Charité
Medical School of Humboldt University (Berlin), Luebeck University Medical
School, Munich University Medical School Grosshadern, Interne Klinik Argirov of
the Munich Comprehensive Cancer Center, University of Erlangen (all of Germany),
University of Verona Medical Center (Italy), Graz University Medical School
(Austria) and Kantonsspital Aarau (Switzerland).




BSD-2000/3D.  Through
research funded by the National Cancer Institute in the United States and
supportive efforts by other domestic and international research institutions, we
enhanced the BSD-2000 to create the new BSD-2000/3D.  The BSD-2000/3D
adds three-dimensional steering of deep focused energy, as opposed to the
two-dimensional steering of energy available in the BSD-2000, delivering even
more precise heating of the tumor.  As part of our international
collaborative research efforts, sophisticated treatment planning software for
the BSD-2000/3D has also been developed.




We have
not yet submitted to the FDA a pre-market approval application for the
BSD-2000/3D.  However, we have obtained the CE Mark necessary to
export the BSD-2000/3D to certain European countries and other countries
requiring CE Mark certification.




BSD-2000/3D/MR.
As a further enhancement of the BSD-2000/3D, we have added to it the option of
concurrent magnetic resonance imaging, or MRI, used for monitoring the delivery
of deep hyperthermia therapy.  Using sophisticated microwave filtering
and imaging software, the BSD-2000/3D/MR allows an MRI system to be interfaced
with and operate simultaneously with a BSD-2000/3D.  The development
of MRI treatment monitoring is a significant breakthrough in the development of
hyperthermic oncology primarily because it allows non-invasive “on-line” review
of hyperthermic treatment progress.




We
installed and tested the first BSD-2000/3D/MR system at a leading German
oncological research institution, the Clinic of Medical Oncology of the Klinikum
Großhadern Medical School of Ludwigs-Maximilians-Universität München, in Munich,
Germany.  We have since installed BSD-2000/3D/MR systems at multiple
other locations.


As is the
case for the BSD-2000/3D, we have not yet submitted to the FDA a pre-market
approval application for the BSD-2000/3D/MR. We can, however, market the
BSD-2000/3D/MR in Europe as we have CE Mark approval for the BSD-2000/3D
provided we interface the system with an MRI system that also is approved in
Europe.




Sales, Marketing and
Distribution




Our
target market includes clinics, hospitals and institutes in which cancer is
treated, whether in the Unites States or international markets.




In
September 2004, we entered into an agreement with Dalian Orientech Co. LTD to
assist us in obtaining regulatory approval for the sale of the BSD-2000 in the
People’s Republic of China, and thereafter to act as our distributor for the
sale of the BSD-2000 in that country.  We subsequently obtained
Chinese regulatory approval during 2005, allowing the distributor to begin to
market in that country, opening the way for BSD-2000 systems to be sold and
installed in hospitals in China.









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 9




Anticipating
an expanding need for present and future sales and marketing, especially with
the potential FDA approval for the BSD-2000 and the MicroThermX-100, we hired
Brian Ferrand, a seasoned Vice President of Sales, in September 2005, and
maintain a sales, marketing and marketing support organization of ten
people.  The primary mission of this group is to provide sales and
pre-market preparation for our systems.




Medizin
Technik is our exclusive distributor of hyperthermia systems in Germany, Austria
and Switzerland and to certain medical institutions in Belgium and the
Netherlands.  Medizin Technik is required to use best efforts to sell
our product within its territory.  Due to the limited number of
systems that are sold through this relationship, we do not have pre-negotiated
price terms with Medizin Technik.  If Medizin Technik identifies a
potential customer, it will negotiate the price of a hyperthermia system with
us, purchase the system, and resell the system to the customer on terms it
negotiates with the customer.  Our distributorship agreement with
Medizin Technik runs from year-to-year and may be terminated by either party by
providing written notice to the other party before December 31 and automatically
terminates upon the occurrence of certain events, including the retirement or
death of Dr. Sennewald.  Dr. Sennewald is a director and significant
shareholder of BSD and of Medizin Technik.




Our sales
and marketing strategy involves three main components:




·
            promoting
      acceptance by the scientific community and cancer-treating healthcare
      professionals of hyperthermia therapy;·
            disseminating
      information about and marketing our hyperthermia therapy systems to the
      scientific community, cancer-treating healthcare professionals, cancer
      patients and the general public; and·
            working
      to continuously improve third-party reimbursement for medical services
      performed with our products.




We
disseminate information about our company and our hyperthermia therapy systems
by encouraging articles about hyperthermia therapy to be published in scientific
journals, periodicals and other publications, and promoting dissemination of BSD
information through television, radio and other media outlets.  We
post information about our products on our web site, www.BSDMedical.com, and our
materials are also posted on many other sites.  Information posted on
our website is not deemed to be part of this Annual Report.  We have
developed promotional materials for our products, including product brochures,
patient brochures and newsletters.  We also participate actively in
trade shows and scientific symposia, make public presentations delivered by our
scientific staff and by scientists and researchers using our systems, and we
actively participate in a variety of medical associations.  We are
co-sponsors of the annual international BSD Users’ Conference in Europe and are
sponsors of the Society of Thermal Medicine and the American Society of
Therapeutic Radiation and Oncology (ASTRO) in the United States.




Third-Party
Reimbursement
  We view
obtaining adequate third-party reimbursement arrangements as essential to
achieving commercial acceptance of our hyperthermia therapy
products.  Our products are purchased primarily by clinics, hospitals
and other medical institutions that bill various third-party payors, such as
Medicare, Medicaid, other government programs and private insurance plans, for
the health care services provided to their patients using our
products.  Additionally, managed care organizations and insurance
companies directly pay for services provided to their patients.  The
Center for Medicare and Medicaid Services, or CMS, has established 23 billing
codes that allow for third-party reimbursement and can be used for or in
combination with the delivery of hyperthermia therapy, depending on the
circumstances of the treatment.  Appropriate codes apply to billing
for superficial and interstitial hyperthermia delivered using our BSD-500
systems when used in combination with radiation therapy.  Codes also
have been established for providing deep hyperthermia
therapy.  Billing codes are available for both institutions and
physicians.


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 10




In
November 1995, HCFA, the predecessor agency to CMS, authorized Medicare
reimbursement for all investigational therapies and devices for which underlying
questions of safety and effectiveness of that device type have been resolved,
based on categorization by the FDA.  Our BSD-2000 system, which has
been given IDE status by the FDA, has been placed in this category by the FDA,
and thus may be reimbursed by Medicare.




Medical
reimbursement rates are unpredictable, and we cannot project the extent to which
our business may be affected by future legislative and regulatory
developments.  There can be no assurance that future health care
legislation or regulation will not have a material adverse effect on BSD’s
business, financial condition and results of operations, or that reimbursement,
existing or in the future, will be adequate for all customers.




Competition




Competition
in the medical products industry is intense.  We believe that
established product lines and cancer therapies, FDA approvals, know-how and
reputation in the industry are key competitive factors.  Currently,
only a few companies besides BSD have received FDA approval to manufacture and
sell hyperthermia therapy systems within the United States, including U.S.
Labthermics and Celsion Corporation.  Celsion has been principally
involved with clinical trials related to thermotherapy, hyperthermia and related
fields, however Celsion has announced the transformation of its company from a
medical device company to a biopharmaceutical, solely focused on the development
of drugs for the treatment of cancer.  Labthermics produces
ultrasound-based systems, which compete with our microwave hyperthermia systems,
however Labthermics is not currently active in the sale of products in our
industry.  Several other companies have received IDEs in the United
States or other international clearance for certain experimental hyperthermia
systems designed to treat both malignant and benign
diseases.  Additionally, other companies, particularly established
companies that currently manufacture and sell other cancer therapy systems,
could potentially become competitors (in that they are also engaged in cancer
treatment businesses), and they have significantly greater resources than we
do.




Competitors
in the thermal ablation market include RadioTherapeutics, a division of Boston
Scientific Corporation, Covidian, Ltd., Angiodynamics, Inc. and Microsulis
Medical Ltd.





Product
Service




We
generally provide a 12-month warranty and record a liability for the warranty
following installation on all cancer treatment systems and a 90-day limited
warranty on individual components.  We install and service the
hyperthermia systems we sell to domestic customers.  In addition, we
or our consultants provide technical and clinical training to our
customers.  Subsequent to the applicable warranty period, we offer our
domestic customers full or limited service contracts.




Generally,
our distributors install and service systems sold to foreign customers and are
responsible for managing their own warranty programs for their customers,
including labor and travel expenses.  We provide warranties for the
replacement and/or repair of parts for 12 months for systems sold
internationally through distributors and for 90 days for individual
components.  Spare parts are generally purchased by the distributors
and stored at the distributors’ maintenance facilities to allow prompt
repair.  Distributor service personnel are usually trained at customer
sites and at our facilities in Salt Lake City, Utah.




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 11


Production




We
manufacture and test our systems and products at our facilities in Salt Lake
City, Utah.  Our manufacturing facility is ISO 13485:2003 certified
and follows FDA quality systems regulations.  Some equipment
components we purchase from suppliers are customized to our
specifications.  Key factors in our manufacturing process are assembly
and testing.  We purchase component parts and other materials from a
variety of suppliers.  We do not depend on a single supplier for any
item, and believe we can acquire materials and parts from multiple sources on a
timely basis.




Product Liability
Exposure




The
manufacturing and marketing of medical devices involves an inherent risk of
product liability.  Because our products are intended to be used in
hospitals on patients who may be physiologically unstable and severely ill, we
are exposed to potential product liability claims.  We presently carry
product liability insurance with coverage limits of $3
million.  However, we cannot assure that our product liability
insurance will provide adequate coverage against potential claims that might be
made against us.  No product liability claims are presently pending
against us; however, we cannot assume that product liability claims will not be
filed in the future or that such claims will not exceed our coverage
limits.




Government
Regulation




The
medical devices that we have developed and are developing are subject to
extensive and rigorous regulation by numerous governmental authorities,
principally by the United States Food and Drug Administration, or FDA, and
comparable foreign agencies.  Pursuant to the Federal Food, Drug and
Cosmetic Act, as amended, the FDA regulates and must approve the clinical
testing, manufacture, labeling, distribution, and promotion of medical devices
in the United States.




Although
our MicroThermX-100 system has received FDA marketing clearance as a 510(k)
submission, most of our hyperthermia treatment systems, including the BSD-500
and the BSD-2000 and related products, have required or require pre-market
approval from the FDA instead of the simpler 510(k)
approval.  Pre-market approval requires that we demonstrate that the
medical device is safe and effective.  To do this, we conduct either
laboratory and/or clinical testing.  The FDA will grant approval of
the product if it determines there is reasonable assurance that the medical
device is safe and effective.  FDA approval must be obtained before
commercial distribution of the product.  We intend to continue to make
improvements in and to our existing products.  Significant product
changes must be submitted to the FDA under investigational device exemptions, or
IDEs, or under pre-market approval supplements.  As described in the
section entitled “Our Products and Services” above, we have obtained a PMA for
our BSD-500 systems and IDE status for our BSD-2000 system.  A PMA
submission was made to the FDA for the BSD-2000 in March 2006.




Foreign
countries, in which our products are or may be sold, have regulatory
requirements that can vary widely from country to country.  Sales into
the European Union, or EU, require compliance with the Medical Devices
Directive, or MDD, and require us to obtain the necessary certifications to have
a CE Mark affixed to our products.  We have obtained necessary ISO
certification of our quality, development, and manufacturing processes, and we
have successfully completed the CE Mark testing and Annex II
audit.  This allows us to certify our own products and to affix the CE
Mark label on them.  However, we must maintain compliance with all
current and future directives and requirements to maintain ISO certification and
to continue to affix the CE Mark, and there can be no assurance that we will
continue to maintain compliance with regulatory requirements imposed on
us.




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 12


After we
receive FDA approval to distribute a medical device, we continue to have ongoing
responsibilities under the Federal Food, Drug, and Cosmetic Act and FDA
regulations.   The FDA reviews design and manufacturing
practices, labeling, record-keeping, and required reporting of adverse
experiences.  All medical devices must be manufactured in accordance
with regulations specified in the FDA Quality System regulations, or QSR, and in
compliance with the ISO and other applicable standards.  In complying
with these regulations, we must continue to expend time, money and effort in the
areas of design control, production, and quality control to ensure full
compliance.  The FDA’s mandatory Medical Device Reporting regulation
requires us to provide information to the FDA on death or serious injuries
alleged to have been associated with the use of our products, as well as
information on product malfunctions that would likely cause or contribute to a
death or serious injury if the malfunctions were to recur.  In Europe,
the MDD vigilance system regulations require that we, through a representative
in Europe, provide information to authorities on death or serious injuries
alleged to have been associated with the use of our products, as well as
information on product malfunctions that would likely cause or contribute to a
death or serious injury if the malfunctions were to recur.  If the FDA
were to assert that we are not in compliance with applicable laws or
regulations, or that any of our medical devices are ineffective or pose an
unreasonable risk to patient health, the FDA could seize our medical devices,
ban such medical devices, or order a recall, repair, replacement or refund of
such devices, and require us to notify health care professionals and others that
the devices present unreasonable risk of substantial harm to the
public.  The FDA may also impose operating restrictions, restrain
certain violations of law, and assess civil or criminal penalties against
us.  The FDA can also recommend prosecution to the Department of
Justice.  Certain regulations are subject to administrative
interpretation and we cannot assure that future interpretations made by the FDA
or other regulatory bodies, with possible retroactive effect, will not adversely
affect us.




International
sales of medical devices are subject to FDA export requirements.  We
have obtained export approvals for all countries into which we have delivered
products.  This includes countries in Western Europe and much of
Eastern Europe and many Asian countries.




International
sales are subject to the regulatory and safety requirements of the country into
which the sale occurs.  There can be no assurance that all of the
necessary approvals will be granted on a timely basis or at
all.  Delays in receipt of or failure to receive such approvals would
have a material adverse effect on our financial condition and results of
operations.




In
addition to FDA regulations, certain U.S. health care laws apply when a claim
for reimbursement for one of our medical devices is submitted to Medicare,
Medicaid, or other federal health care programs.  For instance,
federal law prohibits the filing of false or improper claims for federal
payments.  In addition, federal law prohibits the payment of anything
of value for the purpose of inducing referrals of business reimbursable under a
federal health care program.  Other federal laws prohibit physicians
from making referrals for certain services and items payable under certain
federal programs if the physician has a financial relationship with the entity
providing the service or item.




All of
these laws are subject to evolving interpretations.  If the federal
government were to conclude that we are not in compliance with any of these
health care laws, we could be subject to substantial criminal and civil
penalties, and could be excluded from participation as a supplier to
beneficiaries in federal health care programs.


The
Federal Communications Commission, or FCC, regulates the frequencies of
microwave and radio frequency emissions from medical and other types of
equipment to prevent interference with commercial and governmental
communications networks. The BSD-500 fixed frequency systems and applicators
emit 915 MHz, which is approved by the FCC for medical
applications.  Accordingly, these systems do not require shielding to
prevent interference with communications.  Our BSD-2000 deep
hyperthermia variable-frequency generators and applicators require
electromagnetic shielding.


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 13


Patents, Licenses, and Other
Rights




Because
of the substantial length of time and expense associated with bringing new
products through development and regulatory approval to the marketplace, the
medical device industry places considerable importance on obtaining patent and
trade secret protection for new technologies, products and
processes.  Our policy is to file patent applications to protect
significant technology, inventions and product improvements.  We
currently own two patents in the United States and six patents outside the
United States related to certain components or technology of our hyperthermia
systems.  In addition, five initial patents were assigned to
TherMatrx, for which we obtained a license, four subsequent patents were
obtained and assigned to BSD and we obtained one patent license from the
National Institutes of Health and one from Duke University.  Seven new
U.S. patent applications are pending.  We believe that our patents
represent the early pioneering and dominant patents in this field.




In July
1979, we entered into an exclusive worldwide license for a unique temperature
probe called the Bowman Probe.  The license will remain in effect as
long as the technology does not become publicly known as a result of actions
taken by the licensor.  We pay royalties based upon our sales of the
Bowman Probe.  The license agreement was amended and renewed in August
2000 and is currently in effect.




We also
acquired on December 13, 2001 a patent license from the National Institutes of
Health (NIH) for the U.S. Patent 5,284,114.  This patent is for the
integration of magnetic resonance with hyperthermia systems, including our
BSD-2000/3D/MR system, and is based on a patent obtained by NIH in early
research of the concept. The license agreement requires an annual payment of
$1,000, plus $4,000 per licensed product sold in the U.S., and $1,000 per
licensed product manufactured in the U.S. and sold outside the
U.S.  There is also to be a single payment of $10,000 upon PMA or
510(k) FDA approval.




On July
31, 2007, BSD obtained an exclusive sub-license to a patent owned by Duke
University using phased array technology for the treatment of primary breast
cancer on terms that included hyperthermia equipment upgrades and payment of
some prior patent costs.  This technology and patent is expected to enhance
future developments with the current BSD phased array hyperthermia
systems.




On July
1, 2001, we acquired the rights to all FDA approvals and the rights to
manufacture all cancer products formerly owned by Clini-Therm
Corp.  These products are related to the hyperthermia therapy
delivered by our BSD-500 systems, the exclusive patent obtained from UCSF, and
our enhancements to such systems involve incorporating some of the Clini-Therm
rights we acquired into such systems.  This involved only a one-time
cash payment with no continuing costs.




We cannot
assure that the patents presently issued to us will be of significant value to
us in the future or will be held valid upon judicial
review.  Successful litigation against these patents by a competitor
would have a material adverse effect upon our business, financial condition and
results of operations.  We believe that we possess significant
proprietary know-how in our hardware and software
capabilities.  However, we cannot assure that others will not develop,
acquire or patent technologies similar to ours or that such secrecy will not be
breached.




Research and
Development




Research
and development expenses for fiscal years 2008 and 2007 were $1,737,924 and
$1,875,147.  Research and development expenses in fiscal 2008 related
to the following:




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 14




·
            updating
      of our commercial version of the BSD-2000 with complete modernization of
      the computer system, applicators and patient supports
      and  development of commercial configuration of BSD-2000
      3D/MR·
            completion
      and delivery of the Sigma 40/MR Phased Array for the
      BSD-2000/3D/MR·
            completion
      and delivery of the Sigma 30/MR Phased Array for the
      BSD-2000/3D/MR·
            completion
      and delivery of the 8 Spiral Array for the BSD-500·
            completion
      and delivery of the 24 Spiral Array for the BSD-500·
            completion
      and delivery of the 3 Spiral Array for the BSD-500·
            completion
      and delivery of the 5 Spiral Array for the BSD-500·
            addition
      of the Sigma Ellipse phased array applicator to the standard system
      configuration of the BSD-2000·
            completion
      of new design of the BSD-2000 patient support system for
      commercialization·
            enhancements
      to the BSD-500 and 2000 systems including language translations to German
      and Chinese·
            incorporating
      new development regulations in design process·
            completion
      of the MicroThermX-100 microwave ablation system·
            designing
      a new primary breast phased array applicator·
            working
      with General Electric in design of new BSD-2000/3D/MR at Duke
      University·
            development
      of new microwave ablation disposable applicators and technical research to
      evaluate the various treatment sites and diseases suitable for the
      application of the MicroThermX-100·
            R&D
      projects not publically disclosed




Technological
changes play an important part in the advancement of our industry.  We
intend to continue to devote substantial sums to research and
development.  Research and development efforts inherently involve
costs, risks and uncertainties that could aversely affect our projections,
outlook and operating results.




Seasonality




Our operations are generally not
subject to seasonal fluctuations.





Company
History




BSD was originally incorporated under
the laws of the State of Utah on March 17, 1978.  In July 1986, BSD
was reincorporated in Delaware.


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 15





Segment Information and
Sales Concentrations




We consider our operations to comprise
one business segment.  All of our operating assets are located in the
United States.





A
significant portion of our revenues are derived from sales to Medizin-Technik
GmbH located in Munich, Germany, which is a significant distributor of our
products in Europe and which is owned by Dr. Gerhard W. Sennewald, one of our
directors and a significant stockholder.  For fiscal year 2008 we had
sales of $2,809,132, or 55% of our total sales, from the sale of systems and
various component parts sold to Medizin-Technik, as compared to sales of
$1,385,332, or 49% of our total sales, in fiscal 2007.  Management
believes the terms of the transactions with Medizin-Technik were arms length and
fair to the Company.




A significant portion of our revenues
are derived from sales to foreign customers.  During the years ended
August 31, 2008, 2007 and 2006, total export sales totaled $2,812,796,
$1,787,363 and $2,413,807, or 55%, 63% and 83% of total sales,
respectively.  During fiscal years 2008 and 2007, export sales to
Switzerland were approximately 53% and 44% of total sales,
respectively.  During fiscal year 2006, export sales to China,
Switzerland and Poland were approximately 45%, 21% and 10% of total sales,
respectively.





Backlog





As of August 31, 2008, the Company had
a sales backlog of $1,045,020, including an order from a related party of
$442,500.





Employees




As of August 31, 2008, we had 47
employees; 41 of whom were full-time employees.  None of our employees
are covered by a collective bargaining agreement.  We consider our
relations with our employees to be satisfactory.  We depend upon a
limited number of key management, manufacturing, and technical
personnel.  Our future success will depend in part on our ability to
retain these highly qualified employees.





Available
Information




We file
annual, quarterly and current reports, and other reports and documents with the
Securities and Exchange Commission (the "SEC").  The public may read
and copy any materials we file with the SEC at the SEC's Public Reference Room,
100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on
the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330.  The SEC also maintains an Internet site that contains
reports, proxy and information statements, and other information regarding
issuers that file electronically with the SEC.  The address of that
website is http://www.sec.gov.





The
Company's Internet address is http://www.bsdmc.com.  We make available
on or through our investor link on our website, free of charge, our Annual
Reports on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and any amendments to those reports as soon as reasonably
practicable after this material is electronically filed or furnished to the
SEC.  We also make available, on our website, the charter of the Audit
Committee of our Board of Directors and our Code of
Ethics.  Information contained on our website is not deemed to be a
part of this Annual Report.





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 16





ITEM
1A.  RISK FACTORS





Our
future operating results are highly uncertain.  Before deciding to
invest in BSD Medical or to maintain or increase your investment, you should
carefully consider the risks described below, in addition to the other
information contained in this annual report on Form 10-K.  If any of
these risks actually occur, our business, financial condition or results of
operations could be seriously harmed.  In that event, the market price
for our common stock could decline and you may lose all or part of your
investment.  Although the Company has attempted to list the factors of
which it is currently aware that may have an impact on its operations, there may
be other factors of which the Company is currently unaware or to which it does
not assign sufficient significance, and the following list should not be
considered comprehensive.







We
have a history of significant operating losses and such losses may continue in
the future.




Since our
inception in 1978, our expenses have substantially exceeded our revenue,
resulting in continuing losses and an accumulated deficit of $5,289,252 at
August 31, 2008.  In fiscal 2006, we recorded net income of $9,249,496
which eliminated the accumulated deficit and resulted in positive retained
earnings of $498,042 as of August 31, 2006.  In fiscal years 2008 and
2007, however, we recorded net losses of $2,439,099 and $3,348,195,
respectively, which increased our accumulated deficit to
$5,289,252.




Our net
profit for the fiscal year ended August 31, 2006 was primarily due to the sale
of our ownership in TherMatrx, to American Medical Systems Holdings, Inc., or
AMS.  All revenues from this sale have now been received with no
significant future revenues expected.  We may continue to incur
operating losses in the future as we continue to incur costs to develop our
products, protect our intellectual property and expand our sales and marketing
activities.  To become profitable we will need to increase
significantly the revenues we receive from sales of our hyperthermia therapy
products to sustain and increase our profitability on a quarterly or annual
basis.  We have been unable to do this in the past and we may be
unable to do so in the future, and therefore may never achieve
profitability.




Due
to recent turmoil in global capital markets, we are currently exposed to
fluctuations in the market value of our investments, and impairment of our
investments could harm our results of operations and decrease funds available
for our operations.




We
believe that our current cash and cash equivalents, investments, income tax
refunds receivable, and expected cash provided from operating activities will be
sufficient to fund our operations for the next twelve months.  If the
global credit market continues to deteriorate, our investment portfolio may be
negatively impacted, and we could determine some of our investments have
experienced other-than-temporary declines in fair value, which could adversely
impact our financial results and decrease the amount of the investments
available to fund our operations.  If we cannot replace this source of
cash with cost cutting or cash provided by our operations, we would need to
obtain additional financing.  Due to recent turmoil in global
financial markets, we cannot be certain that any financing will be available
when needed or will be available on terms acceptable to us.




Our
hyperthermia therapy products may not achieve market acceptance which could
limit our future revenue and ability to achieve profitability.




To date,
hyperthermia therapy has not gained wide acceptance by cancer-treating
physicians.  We believe this is due in part to the lingering
impression created by the inability of early hyperthermia therapy technologies
to focus and control heat directed at specific tissue locations and conclusions
drawn in early scientific studies that hyperthermia was only marginally
effective.  Additionally, market acceptance depends upon physicians
and hospitals obtaining adequate reimbursement rates from third-party payors to
make our products commercially viable, and we believe that reimbursement rates
have not been adequate to stimulate strong interest in adopting hyperthermia as
a new cancer therapy.  If our sales and marketing efforts to promote
hyperthermia therapy acceptance in the medical community fail, or our efforts to
improve third-party reimbursement rates for hyperthermia therapy are not
successful, then our future revenue from sales of our products may be limited,
and we may never be able to obtain profitable recurring operations.




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Sales
of our product could be significantly reduced if government, private health
insurers and other third-party payors do not provide sufficient coverage or
reimbursement.




Our
success in selling our products will depend in large part on the extent to which
reimbursement for the costs of our products and related treatments are available
from government health agencies, private health insurers and other third-party
payers.  Despite the existence of general reimbursement policies,
local medical review policies may differ for public and private insurance
payers, which may cause payment to be refused for some hyperthermia
treatments.  Private payers also may refuse to pay for hyperthermia
treatments.




Medical
reimbursement rates are unpredictable and we cannot predict the extent to which
our business may be affected by future legislative and regulatory
developments.  Future health care legislation or regulation may limit
our business or impose additional delays and costs on our business and
third-party reimbursement may not be adequate to cover our costs associated with
producing and selling our products.




Cancer
therapy is subject to rapid technological change and therapies that are more
effective than ours could render our technology obsolete.




The
treatment of cancer is currently subject to extensive research and
development.  Many cancer therapies are being researched and our
products may be rendered obsolete by existing therapies and as a result of
therapy innovations by others.  If our products are rendered obsolete,
our revenue will decline, we may never achieve profitability, and we may not be
able to continue in business.




Some
of the medical institutions to which we have sold in the past have not been able
to pay for their equipment, and some of our sales have therefore become
substantial bad debts, a risk that could continue into the future.




A limited
number of our customers have been developing clinics, and these customers have
been particularly vulnerable to financial difficulties that can cause them to be
unable to pay for equipment that they have purchased. If we choose to accept
higher risk sales opportunities to clinics in the future, we will be subject to
these customer credit risks that could lower future net sales due to bad-debt
write offs, resulting in losses in future periods and potentially lowering the
value of our stock.  While we attempt to provide for foreseeable
doubtful accounts, we cannot assure that this provision will always be adequate
to cover our credit risks.




Increasing
sales of our hyperthermia systems depends on our ability to successfully expand
our sales distribution channels; we have had failures with the productivity of
new channels of distribution in the past.  Expanding our channels of
distribution will also significantly increase our sales expenses, which could
negatively impact our financial performance.




We
believe that the success of our efforts to increase sales of our hyperthermia
systems in the future depends on our ability to successfully expand our sales
distribution channels.  Historically, we have sometimes failed in
establishing successful new sales channels.




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 18


We
anticipate that the success of our multi-year plan for selling hyperthermia
systems will require expanding our sales and marketing organization through a
combination of direct sales people, distributors and internal and external
marketing expertise.  However, as we pursue our marketing plan, there
can be no assurance that we will be successful in securing reliable channels of
distribution to meet our plan through expanded sales.  Recruiting and
training new distribution channels can take time and considerable expense. We
project that sales and marketing expenses will increase substantially in the
future as compared to past years.  This added expense could have an
adverse effect on our future financial performance that is greater than any
potential increases in sales.




In
addition, there can be no assurance that our channels of distribution that have
been successful in the past will be successful in the future.  We have
derived a significant portion of our revenue from sales in Europe and in
China.  Sales in Europe were made through our distributor
Medizin-Technik, GmbH, which also purchases equipment components and parts from
us.  Medizin-Technik is controlled by Dr. Sennewald, one of our
directors.  The loss or ineffectiveness of either Medizin-Technik or
our Chinese distributor as a distributor and significant customer could result
in lower revenue.




We
are subject to government regulations that can delay our ability to sell our
products and cause us to incur substantial expenses.




Our
research and development efforts, pre-clinical tests and clinical trials, and
the manufacturing, marketing, distribution and labeling of our products are
subject to extensive regulation by the FDA and comparable international
agencies.  The process of obtaining FDA and other required regulatory
approvals is lengthy and expensive and our financial resources are
limited.




We have
not yet received pre-market approval for our BSD-2000 or its related products.
Obtaining this pre-market approval from the FDA is necessary for us to
commercially market this system in the United States. Obtaining approvals is a
lengthy and expensive process.  We may not be able to obtain these
approvals on a timely basis, if at all, and such failure could harm our business
prospects substantially. Further, even if we are able to obtain the approvals we
seek from the FDA, the approvals granted might include significant limitations
on the indicated uses for which the products may be marketed, which restrictions
could negatively impact our business.




After a
product is approved for commercial distribution by the FDA, we have ongoing
responsibilities under the Federal Food, Drug, and Cosmetic Act and FDA
regulations, including regulation of our manufacturing facilities and processes,
labeling and record-keeping, and reporting of adverse experiences and other
information.  Failure to comply with these ongoing requirements could
result in the FDA imposing operating restrictions on us, enjoining or
restraining certain violations, or imposing civil or criminal penalties on
us.




All of
these laws are subject to evolving interpretations.  If the federal
government were to conclude that we are not in compliance with any of these
health care laws, we could be subject to substantial criminal and civil
penalties, and could be excluded from participation as a supplier to
beneficiaries in federal health care programs.




We
depend on adequate protection of our patent and other intellectual property
rights to stay competitive.




We rely
on patents, trade secrets, trademarks, copyrights, know-how, license agreements
and contractual provisions to establish and protect our intellectual property
rights.  Our success will substantially depend on our ability to
protect our intellectual property rights and maintain rights granted to us
through license agreements.  Our intellectual property rights may only
afford us limited protection and may not adequately protect our rights or
remedies to gain or keep any advantages we may have over our competitors, which
could reduce our ability to be competitive and generate sales and
profitability.




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 19


In the
past, we have participated in substantial litigation regarding our patent and
other intellectual property rights in the medical device industry.  We
have previously filed lawsuits for patent infringement against three of our
competitors and subsequently settled all three of those
lawsuits.  Additional litigation against other parties may be
necessary in the future to enforce our intellectual property rights, to protect
our patents and trade secrets, and to determine the validity and scope of our
proprietary rights.  This litigation may require more financial
resources than are available to us.  We cannot guarantee that we will
be able to successfully protect our rights in litigation.  Failure to
successfully protect our rights in litigation could reduce our ability to be
competitive and generate sales and profitability.




A
product liability settlement could exceed our ability to pay.




The
manufacturing and marketing of medical devices involves an inherent risk of
product liability.  Because our products are intended to be used in
hospitals on patients who may be physiologically unstable and severely ill, we
are exposed to potential product liability claims.  We presently carry
product liability insurance with coverage limits of $3 million.  Our
product liability insurance does not cover intended injury, injury or damage
resulting from the intoxication of any person, payment of workers’ compensation
benefits, injury of our own employee, injury or damage due to war, damage to
property that we own, damage to our work, loss of use of property, patent
infringements, pollution claims, interest payments, depreciation of property, or
injury or damage resulting from asbestos inhalation.  We are
responsible to pay the first $10,000 resulting from any claim up to a maximum of
$50,000 in one year.  We cannot assure that our product liability
insurance will provide adequate coverage against potential claims that might be
made against us.  If we were to be subject to a claim in excess of our
coverage or to a claim not covered by our insurance and the claim succeeded, we
would be required to pay the claim from our limited resources, which would
reduce our limited capital resources and liquidity and reduce capital we could
otherwise use to obtain approvals for and market our products.  In
addition, liability or alleged liability could harm our business by diverting
the attention and resources of our management and by damaging our
reputation.




We
are dependent upon key personnel, some of whom would be difficult to
replace.




Our
success will be largely dependent upon the efforts of Paul F. Turner, our
Chairman of the Board, Senior Vice President, and Chief Technology Officer,
Hyrum A. Mead, our President, and Dixie T. Sells, our Vice President of
Regulatory Affairs, and other key employees.  We do not maintain
key-person insurance on any of these employees.  Our future success
also will depend in large part upon our ability to identify, attract and retain
other highly qualified managerial, technical and sales and marketing
personnel.  Competition for these individuals is
intense.  The loss of the services of any of our key personnel, the
inability to identify, attract or retain qualified personnel in the future or
delays in hiring qualified personnel could make it more difficult for us to
manage our business and meet key objectives such as the sale of our products and
the introduction of new products.




The
market for our stock is limited and our stock price may be
volatile.




The
market for our common stock has been limited due to low trading volume and the
small number of brokerage firms acting as market makers.  Because of
the limitations of our market and volatility of the market price of our stock,
investors may face difficulties in selling shares at attractive prices when they
want to.  The average daily trading volume for our stock has varied
significantly from week to week and from month to month, and the trading volume
often varies widely from day to day.  The following factors could
impact the market for our stock and cause further volatility in our stock
price:




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 20




·
            announcements
      of new technological innovations;·
            FDA
      and other regulatory developments;·
            changes
      in third-party reimbursements;·
            developments
      concerning proprietary rights;·
            third
      parties receiving FDA approval for competing products;
  and·
            market
      conditions generally for medical and technology
  stocks.




Our
directors and executive officers own a sufficient number of shares of our
capital stock to control our company, which could discourage or prevent a
takeover, even if an acquisition would be beneficial to our
stockholders.




Our
directors and executive officers own approximately 43% of our outstanding voting
power.  Accordingly, these stockholders, individually and as a group,
may be able to influence the outcome of stockholder votes involving the election
of directors, the adoption or amendment of provisions in our certificate of
incorporation and bylaws and the approval of certain mergers or other similar
transactions, such as a sale of substantially all of our assets.  Such
control by existing stockholders could have the effect of delaying, deferring or
preventing a change in control of our company.




Anti-takeover
provisions in our certificate of incorporation may have a possible negative
effect on our stock price.




Certain
provisions of our certificate of incorporation and bylaws may make it more
difficult for a third party to acquire, or discourage a third party from
attempting to acquire, control of us.  We have in place several
anti-takeover measures that could discourage or prevent a takeover, even if an
acquisition would be beneficial to our stockholders.  The increased
difficulties faced by a third party who wishes to acquire us could adversely
affect our stock price.







ITEM
1B.  UNRESOLVED STAFF COMMENTS





None.





ITEM
2.  PROPERTIES





Our
office, production and research facilities are located in Salt Lake City,
Utah.  The complete headquarters and production facility occupies
approximately 20,000 square feet.  When our lease on this building
expired in November of 2007, we exercised our option to purchase the building
for a purchase price of $1,200,000.  The building is currently in good
condition, is adequate for our needs, is suitable for all company functions and
provides room for future expansion.  We believe that we carry adequate
insurance on the property.




ITEM
3.  LEGAL PROCEEDINGS





There are
no material legal proceedings, to our knowledge, pending against or being taken
by BSD Medical Corporation.





ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS





None.


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 21


PART
II





ITEM
5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES





On July
9, 2005, the American Stock Exchange (AMEX) approved the listing for BSD Medical
Corporation and the shares began trading on that day under the symbol
“BSM”.  On April 22, 2008, the shares began trading on the Nasdaq
Stock Market under the symbol “BSDM”.  The following table sets forth
the high and low sales prices, as provided by AMEX and NASDAQ for the quarters
in fiscal year 2007 and 2008.  The amounts reflect inter-dealer
prices, without retail mark-up, markdown or commission, and may not represent
actual transactions.




Quarter
      Ended:
            High
            LowNovember
      30, 2006
            $5.90
            $4.45February
      28, 2007
            9.25
            5.00May
      31, 2007
            9.00
            5.75August
      31, 2007
            8.72
            4.60November
      30, 2007
            7.11
            4.89February
      29, 2008
            6.35
            4.30May
      31, 2008
            7.50
            4.57August
      31, 2008
            8.20
            5.00




As of
August 31, 2008, there were approximately 491 holders of record of our common
stock.  We have not paid any cash dividends on our common stock since
our inception, and we currently plan to retain our future earnings, if any, to
fund the growth of our business.




On
November 7, 2008, the last reported sales price of our common stock on the
Nasdaq Stock Market was $ 4.92 per share.




Repurchases
of Equity Securities




None.




Recent
Sales of Unregistered Securities




Following is a summary of sales of
unregistered securities for the fiscal year ended August 31,
2008.  The Company issued 4,616 shares of its common stock on
September 1, 2007 and 5,898 shares of its common stock on March 4, 2008 to
members of the Board of Directors pursuant to the Company’s Amended and Restated
1998 Directors Stock Plan.  All securities were issued as restricted
common shares pursuant to Section 4(2) of the Securities Act of 1933, as
amended, and/or the rules promulgated pursuant to Section 4(2).  These
shares are generally subject to Rule 144 of the Securities and Exchange
Commission.  Generally, Rule 144 requires shareholders to hold the
shares for a minimum of six months before sale.  In addition,
officers, directors and more than 10% shareholders are further restricted in
their ability to sell such shares.  There have been no underwriters of
these securities and no commissions or underwriting discounts have been
paid.





Consideration
      or Nature of Service Performed
            
            Shares
      Issued
            
            
            Value
      ReceivedMembers
      of Board of Directors
            Board
      Services
            
            
            10,514
            
            
            
            $       
      61,195





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 22


Performance
Graph





The
following graph shows a comparison of the five-year cumulative total return for
the Company's common stock, the S&P 500 Index, and the S&P Health Care
Equipment Index, assuming an investment of $100 on August 31,
2003.  The cumulative return of the Company was computed by dividing
the difference between the price of the Company's common stock at the end and
the beginning of the measurement period (August 31, 2003 to August 31, 2008) by
the price of the Company's common stock at the beginning of the measurement
period.











ITEM
6.  SELECTED FINANCIAL DATA





The
following selected financial data as of and for each of the fiscal years in the
five year period ended August 31, 2008 were derived from the Company’s financial
statements audited by Tanner LC, independent registered public
accountants.  The data set forth below should be read in conjunction
with “Management's Discussion and Analysis of Financial Condition and Results of
Operations” included in Item 7 of this Form 10-K and the financial statements
and notes thereto included in Item 8 of this Form 10-K.  See also the
discussion in “The Sale of TherMatrx” included in Item 1, “Business”, of this
Form 10-K.




Years
      Ended August 31,2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004Results of Operations
      Data:Revenues
            
            $
            5,143,140
            
            
            $
            2,834,386
            
            
            $
            2,898,402
            
            
            $
            2,021,104
            
            
            $
            1,630,648Loss
      from operations
            
            
            (4,252,344
            )
            
            
            (6,384,540
            )
            
            
            (5,099,151
            )
            
            
            (2,293,696
            )
            
            
            (1,290,618
            )Net
      income (loss)
            
            
            (2,439,099
            )
            
            
            (3,348,195
            )
            
            
            9,249,496
            
            
            
            3,321,692
            
            
            
            8,412,961Income
      (loss) per common share - diluted
            
            $
            (0.11
            )
            
            $
            (0.16
            )
            
            $
            0.42
            
            
            $
            0.15
            
            
            $
            0.41Dividends
      per common share
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Balance
      Sheet Data:Total
      Assets
            
            $
            21,486,898
            
            
            $
            24,341,640
            
            
            $
            28,309,868
            
            
            $
            15,599,943
            
            
            $
            11,741,047Long-term
      debt
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stockholders'
      equity
            
            
            20,155,860
            
            
            
            23,183,788
            
            
            
            25,624,001
            
            
            
            14,977,667
            
            
            
            11,119,778





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 23





ITEM
7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF
OPERATIONS




Overview





This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations and other parts of this annual report on Form 10-K contain
forward-looking statements that involve risks and
uncertainties.  Forward-looking statements can also be identified by
words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and
similar terms.  Forward-looking statements are not guarantees of
future performance and our actual results may differ significantly from the
results discussed in the forward-looking statements.  Factors that
might cause such differences include, but are not limited to, those discussed in
the subsection entitled “Forward-Looking Statements” below and the Item 1A “Risk
Factors” above.  The following discussion should be read in
conjunction with our financial statements and notes thereto included in this
annual report on Form 10-K.  All information presented herein is based
on our fiscal year ended August 31, 2008.  We assume no obligation to
revise or update any forward-looking statements for any reason, except as
required by law.




BSD
Medical Corporation develops, manufactures, markets and services medical systems
that deliver precision-focused radio frequency (RF) or microwave energy into
diseased sites of the body, heating them to specified temperatures as required
by a variety of medical therapies.  Our business objectives are to
commercialize our products developed for the treatment of cancer and to further
expand our developments to treat other diseases and medical
conditions.  Our product line for cancer therapy has been created to
offer hospitals and clinics a complete solution for thermal treatment for cancer
as provided through microwave/RF systems.




On July
15, 2004, TherMatrx, Inc. was sold to American Medical Systems Holdings, Inc.
(AMS).  Our part of the total proceeds from this sale was
approximately 25%.  A portion of the payout from the sale was based on
contingency payments.  By the close of fiscal year 2006, the Company
had received a total payout, including contingency payments, of approximately
$33.5 million.  In April 2007, the Company received an additional
$202,223 in proceeds from the sale of TherMatrx.





Our
accumulated deficit since inception increased to $5,289,252 as of August 31,
2008 due to net losses for fiscal years 2008 and 2007, as compared to net income
for fiscal 2006 of $9,249,496.  The primary reason for the net income
in fiscal 2006 was the income generated from the sale of our ownership in
TherMatrx.




We
recognize revenue from the sale of cancer treatment systems, the sale of parts
and accessories related to the cancer treatment systems, providing manufacturing
services, training, and service support contracts.  Product sales were
$4,631,713, $2,520,818 and $2,706,214 for the years ended August 31, 2008, 2007
and 2006, respectively.  Service and other revenues were $511,427,
$313,568 and $192,188 for the years ended August 31, 2008, 2007 and 2006,
respectively.




We
derived $2,809,132, or approximately 55%, of our total revenue in fiscal 2008
from sales to related parties, as compared to $1,385,332, or 49% from sales to
related parties in fiscal 2007.  All of the related party revenue was
for the sale of the BSD-2000 and BSD-500 systems and related component parts and
services sold to Medizin-Technik GmbH.  Dr. Gerhard Sennewald, one of
our directors, is a stockholder, executive officer and a director of
Medizin-Technik GmbH.




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 24


In fiscal
2008, we derived $2,334,008, or approximately 45%, of our total revenue as
compared to $1,449,054, or 51%, in fiscal 2007 from non-related party
sales.  Our fiscal 2008 non-related party revenue consisted of sales
of our BSD-500 systems and other products of $2,218,700, consumable devices of
$16,247, service contracts of $56,968, and consulting and other revenue of
$42,093.  Our fiscal 2007 non-related party revenue consisted of sales
of our BSD-500 systems of $1,347,887, consumable devices of $22,970, service
contracts of $41,338, billable labor of $550 and consulting and other revenue of
$36,309.




Cost of
sales for the years ended August 31, 2008 and 2007 included raw material and
labor costs.  Research and development expenses include expenditures
for new product development and development of enhancements to existing
products.




As of
August 31, 2008, the Company had a sales backlog of $1,045,020, including an
order from a related party of $442,500.





Critical Accounting
Policies





The
following is a discussion of our critical accounting policies and estimates that
management believes are material to an understanding of our results of
operations and which involve the exercise of judgment or estimates by
management.




Revenue
Recognition.  Revenue from the sale of cancer treatment systems
is recognized when a purchase order has been received, the system has been
shipped, the selling price is fixed or determinable, and collection is
reasonably assured.  Most system sales are F.O.B. shipping point;
therefore, shipment is deemed to have occurred when the product is delivered to
the transportation carrier.  Most system sales do not include
installation.  If installation is included as part of the contract,
revenue is not recognized until installation has occurred, or until any
remaining installation obligation is deemed to be perfunctory.  Some
sales of cancer treatment systems may include training as part of the
sale.  In such cases, the portion of the revenue related to the
training, calculated based on the amount charged for training on a stand-alone
basis, is deferred and recognized when the training has been
provided.  The sales of our cancer treatment systems do not require
specific customer acceptance provisions and do not include the right of return,
except in cases where the product does not function as warranted by
us.  We provide a reserve allowance for estimated
returns.  To date, returns have not been significant.




Revenue
from manufacturing services is recorded when an agreement with the customer
exists for such services, the services have been provided, and collection is
reasonably assured.  Revenue from training services is recorded when
an agreement with the customer exists for such training, the training services
have been provided, and collection is reasonably assured.  Revenue
from service support contracts is recognized on a straight-line basis over the
term of the contract.




Our
revenue recognition policy is the same for sales to both related parties and
non-related parties.  We provide the same products and services under
the same terms to non-related parties as to related parties.  Sales to
distributors are recognized in the same manner as sales to end-user
customers.  Deferred revenue and customer deposits payable include
amounts from service contracts as well as cash received for the sales of
products, which have not been shipped.




Inventory
Reserves.  We periodically
review our inventory levels and usage, paying particular attention to
slower-moving items.  If projected sales do not materialize or if our
hyperthermia systems do not receive increased market acceptance, we may be
required to increase the reserve for inventory impairment in future
periods.




Product
Warranty.  We provide product warranties on our BSD-500 and
BSD-2000 systems.  These warranties vary from contract to contract,
but generally consist of parts and labor warranties for one year from the date
of installation.  To date, expenses resulting from such warranties
have not been material.  We record a warranty expense at the time of
each sale.  This reserve is estimated based on prior history of
service expense associated with similar units sold in the past.




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 25




Allowance for
Doubtful Accounts.We maintain allowances for
doubtful accounts for estimated losses resulting from the inability of our
customers to make required payments.  This allowance is a significant
estimate and is regularly evaluated by us for adequacy by taking into
consideration factors such as past experience, credit quality of the customer
base, age of the receivable balances, both individually and in the aggregate,
and current economic conditions that may affect a customer’s ability to
pay.  If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.




Stock-based
Compensation – We account for stock-based compensation in accordance with
SFAS No. 123(R), which requires us to measure the compensation cost of stock
options and other stock-based awards to employees and directors at fair value at
the grant date and recognize compensation expense over the requisite service
period for awards expected to vest.  The grant date fair value of
stock options is computed using the Black-Scholes valuation model, which model
utilizes inputs that are subject to change over time, including the volatility
of the market price of our common stock, risk free interest rates, requisite
service periods and assumptions made by us regarding the assumed life and
vesting of stock options and stock-based awards.  As new options or
stock-based awards are granted, additional non-cash compensation expense will be
recorded by us.





Income
Taxes – We account for income taxes using the asset and liability
method.  Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases.  Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled.  The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.





We
maintain valuation allowances where it is more likely than not that all or a
portion of a deferred tax asset will not be realized.  Changes in
valuation allowances are included in our income tax provision in the period of
change.  In determining whether a valuation allowance is warranted, we
evaluate factors such as prior earnings history, expected future earnings and
our ability to carry-back reversing items within two years to offset income
taxes previously paid.





To the
extent that we have the ability to carry-back current period taxable losses
within two years to offset income taxes previously paid, we record an income tax
receivable and a current income tax benefit.








Results of Operations:
Comparison of Fiscal Years ended August 31, 2008 and 2007




Revenues –
Total revenues for fiscal 2008 were $5,143,140 compared to $2,834,386 for fiscal
2007, an increase of $2,308,754, or 81%.  Our revenues can fluctuate
significantly from period to period because our sales, to date, have been based
upon a relatively small number of systems, the sales price of each being
substantial enough to greatly impact revenue levels in the periods in which they
occur.  Sales of a few systems can cause a large change in our
revenues from period to period.




Related Party
Sales – We earned $2,809,132, or approximately 55%, of our revenues in
the year ended August 31, 2008 from sales to related parties as compared to
$1,385,332 or approximately 49%, in the year ended August 31,
2007.  These sales for the years ended August 31, 2008 and 2007 were
to Medizin-Technik and increased in fiscal year 2008 due to an increased number
of systems sold.  The sales consisted of product sales of $2,623,013,
probes of $38,550 and other revenues of $147,569 in fiscal year 2008, and
product sales of $1,172,930, probes of $47,902 and other revenues of $164,500 in
fiscal year 2007.  Sales to Medizin-Technik may fluctuate
significantly from period to period because our sales, to date, have been based
upon a relatively small number of systems, the sales price of each being
substantial enough to greatly impact revenue levels in the periods in which they
occur.  Sales of a few systems can cause a large change in our revenue
from period to period.




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 26


Non-Related Party
Sales – In the year ended August 31, 2008, we earned $2,334,008, or 45%,
of our revenues from sales to unrelated parties, as compared to $1,449,054, or
51%, for the year ended August 31, 2007, with the increase due primarily to more
systems sold in the current fiscal year.  These sales for the year
ended August 31, 2008 consisted of product sales of $2,218,700, service
contracts of $56,968, probes of $16,247 and consulting and other revenue of
$42,093.  By comparison, these sales for the year ended August 31,
2007 consisted of product sales of $1,347,887, service contracts of $41,338,
probes of $3,300 and consulting and other revenue of $56,529.




Cost of
Sales – Cost of sales for fiscal 2008 was $2,084,249 compared to
$1,581,562 for fiscal 2007, an increase of $502,687, or 32%.  This
increase resulted primarily from more product sales in fiscal
2008.  Cost of sales as a percentage of sales will fluctuate from
period to period depending on the mix of sales for the period.  Cost
of sales to related parties in fiscal 2008 increased to $1,128,029 from $815,522
in fiscal 2007 primarily due to the increase in related party product
sales.  During fiscal 2008 and 2007, all of the related party cost of
sales were attributable to sales to Medizin-Technik.




Gross
Profit – Gross profit for the year ended August 31, 2008 was $3,058,891
or 59% of total sales, as compared to $1,252,824 or 44% of total sales for the
year ended August 31, 2007.  The increase in gross profit in fiscal
year 2008 primarily resulted from the increase in product sales, for which our
gross profit is higher than our other sources of revenue.  In
addition, as sales volume increases, we believe we will more fully absorb our
fixed overhead costs, thus increasing our gross profit
percentage.  The gross margin percentage will fluctuate from period to
period depending on the mix of revenues reported for the period.




Research and
Development Expenses – Research and development expenses were $1,737,924
for the year ended August 31, 2008, as compared to $1,875,147, for the year
ended August 31, 2007, a decrease of $137,223, or approximately
7%.  See the discussion under “Research and Development” in Item 1,
“Business” of this Annual Report.




Selling General
and Administrative Expenses – Selling, general and administrative
expenses remained fairly constant, decreasing to $5,573,311 in the year ended
August 31, 2008, from $5,762,217 for the year ended August 31, 2007, a decrease
of $188,906, or approximately 3%.  We anticipate that our selling,
general and administrative expenses will continue at this level, at least in the
short term.




Interest and
Investment Income – Interest and investment income decreased to
$1,046,313 for the year ended August 31, 2008, as compared to $1,133,125 for the
year ended August 31, 2007, due to lower average levels of cash and investments
and lower rates of return realized in the current fiscal year.




Gain on Sale of
Equity Interest – Other income for fiscal 2007 included $202,223 of
additional proceeds received from the sale of our equity interest in
TherMatrx.  During fiscal 2008, we did not receive any proceeds from
the sale of this equity interest.




Net Income
(Loss) – During
the year ended August 31, 2008 we had a net loss of $2,439,099, after recording
a tax benefit of $961,000, as compared to a net loss of $3,348,195, after
recording a tax benefit of $1,865,000, in the year ended August 31,
2007.  The decrease in the net loss in the current fiscal year is due
primarily to the increase in total revenues as discussed above.




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 27





Results of Operations:
Comparison of Fiscal Years ended August 31, 2007 and 2006




Revenues –
Total revenues for fiscal 2007 were $2,834,386 compared to $2,898,402 for fiscal
2006, a decrease of $64,016, or 2%.  Our revenues can fluctuate
significantly from period to period because our sales, to date, have been based
upon a relatively small number of systems, the sales price of each being
substantial enough to greatly impact revenue levels in the periods in which they
occur.  Sales of a few systems can cause a large change in our
revenues from period to period.




Related Party
Sales – We earned $1,385,332, or approximately 49%, of our revenues in
the year ended August 31, 2007 from sales to related parties as compared to
$689,086 or approximately 24%, in the year ended August 31,
2006.  These sales for the year ended August 31, 2007 were to
Medizin-Technik and consisted of product sales of $1,172,930, probes of $47,902
and other revenues of $164,500.  All of the related party revenues in
the year ended August 31, 2006 was from sales of systems and component
parts.  Sales to Medizin-Technik may fluctuate significantly from
period to period because our sales, to date, have been based upon a relatively
small number of systems, the sales price of each being substantial enough to
greatly impact revenue levels in the periods in which they
occur.  Sales of a few systems can cause a large change in our revenue
from period to period.




Non-Related Party
Sales – In the year ended August 31, 2007, we earned $1,449,054, or 51%,
of our revenues from sales to unrelated parties, as compared to $2,209,316, or
76%, for the year ended August 31, 2006.  These sales for the year
ended August 31, 2007 consisted of product sales of $1,347,887, service
contracts of $41,338, probes of $3,300 and consulting and other revenue of
$56,529. By comparison, these sales for the year ended August 31, 2006 consisted
of product sales of $1,902,175, sales of consumable devices of $126,896, service
contracts of $18,245, and consulting and other revenue of $162,000.




Cost of
Sales – Cost of sales for fiscal 2007 was $1,581,562 compared to
$1,716,640 for fiscal 2006, a decrease of $135,078 or 8%.  This
decrease resulted primarily from lower sales in fiscal 2007.  Cost of
sales as a percentage of sales will fluctuate from period to period depending on
the mix of sales for the period.  Cost of sales to related parties in
fiscal 2007 increased to $815,522 from $317,214 in fiscal 2006 primarily due to
the increase in related party sales.  During fiscal 2007 and 2006, all
of the related party cost of sales were attributable to sales to
Medizin-Technik.




Gross
Profit – Gross profit for the year ended August 31, 2007 was $1,252,824
or 44% of total sales, as compared to $1,181,762 or 41% of total sales for the
year ended August 31, 2006.    As sales volume increases, we
believe we will more fully absorb our fixed overhead costs, thus increasing our
gross profit percentage.  The gross margin percentage will also
fluctuate from period to period depending on the mix of revenues reported for
the period.




Research and
Development Expenses – Research and development expenses were $1,875,147
for the year ended August 31, 2007, as compared to $1,251,956, for the year
ended August 31, 2006, an increase of $623,191, or approximately 50%. Research
and development expenses in the year ended August 31, 2007 increased due to
expanded activities related to the following:




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·
            Update
      of our commercial version of the BSD-2000 with complete modernization of
      the computer system, including addition of the Sigma Ellipse phased array
      applicator.·
            Support
      for field implementation of a complete new design of the BSD-2000 patient
      support system, enhancements to the BSD 500 and 2000 systems including
      language translations of the operating manuals to German and Chinese and
      development of various spiral array applicator systems to compliment the
      BSD-500.·
            PMA
      filing for the BSD-2000 system, and development of the first model of the
      MicroThermX-100 microwave ablation system.·
            Development
      of new microwave ablation disposable applicators.·
            Technical
      research to evaluate the various treatment sites and diseases suitable for
      the application of the
MicroThermX-100.




Selling General
and Administrative Expenses – Selling, general and administrative
expenses increased to $5,762,217 in the year ended August 31, 2007, from
$5,028,957 for the year ended August 31, 2006, an increase of $733,260 or
approximately 15%.  This increase was primarily due to a non-cash
stock-based compensation expense of $832,224 related to issuance of stock
options.




Interest and
Investment Income – Interest and investment income decreased to
$1,133,125 for the year ended August 31, 2007, as compared to $1,301,341 for the
year ended August 31, 2006, due to lower average levels of cash and investments
in the year ended August 31, 2007.




Gain on Sale of
Equity Interest – Other income for fiscal 2007 included $202,223 of
additional proceeds received from the sale of our equity interest in
TherMatrx.  During fiscal 2006, we recognized a gain on sale of our
equity interest in TherMatrx of $18,016,272.




Net Income
(Loss) – During
the year ended August 31, 2007 we had a net loss of $3,348,195, after recording
a tax benefit of $1,865,000, as compared to an after tax net income of
$9,249,496 in the year ended August 31, 2006.  The net income in the
previous fiscal year was attributed primarily to the gain on sale of our
investment in TherMatrx.




Fluctuation
in Operating Results.




Our
results of operations have fluctuated in the past and may fluctuate in the
future from year to year as well as from quarter to quarter.  Revenue
may fluctuate as a result of factors relating to the demand for thermotherapy
systems and component parts supplied by us to TherMatrx, market acceptance of
our BSD hyperthermia systems, changes in the medical capital equipment market,
changes in order mix and product order configurations, competition, regulatory
developments and other matters.  Operating expenses may fluctuate as a
result of the timing of sales and marketing activities, research and development
and clinical trial expenses, and general and administrative expenses associated
with our potential growth.  For these and other reasons described
elsewhere, our results of operations for a particular period may not be
indicative of operating results for any other period.




Liquidity and Capital
Resources




Since
inception through August 31, 2008, we have generated an accumulated deficit of
$5,289,252.  We have historically financed our operations through cash
from operations, research grants, licensing of technological assets, issuance of
common stock and sale of investments in spinoff operations.  As of
August 31, 2008, we had cash, cash equivalents and investments totaling
$15,881,844 as compared to cash, cash equivalents and investments totaling
$19,506,658 as of August 31, 2007.  The recorded value of our
investments at August 31, 2008 has been reduced by an unrealized loss of
$2,141,416.




During
the year ended August 31, 2008, we used cash of $902,576 in operating
activities, primarily as a result of our net loss of $2,439,099, decrease in
income tax receivable of $521,717, decrease in inventories of $84,914, decrease
in deferred tax assets of $244,000 and increase in customer deposits of
$213,039, partially offset by an increase in receivables of
$485,755.  By comparison, net cash used in operating activities was
$5,120,462 during the year ended August 31, 2007, which included an increase in
income tax receivable of $1,752,492 and a reduction of income taxes payable of
$1,500,000.




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 29


Net cash
provided by investing activities for the year ended August 31, 2008 was
$1,722,206, resulting from the net sale of investments of $3,034,270, partially
offset by the purchase of property and equipment of $1,291,098, which was
primarily comprised of the acquisition of our office facility, and the purchase
of a patent for $20,966.  For the year ended August 31, 2007, net cash
provided by investing activities was $3,128,201, resulting from the net sale of
investments of $2,992,590, additional proceeds from the sale of investment in
TherMatrx of $202,223, partially offset by the purchase of property and
equipment of $66,612.




Net cash
provided by financing activities consisted of proceeds from the sale of common
stock through the exercise of stock options of $158,482 in the year ended August
31, 2008 and $229,707 for the year ended August 31, 2007.




We expect
to incur additional expenses related to the commercial introduction of our
systems, due to additional participation at trade shows, expenditures on
publicity, additional travel, increased sales salaries and commissions and other
related expenses. In addition, we anticipate that we will incur increased
expenses related to seeking governmental and regulatory approvals for our
products and continued expenses related to corporate governance and compliance
with the Sarbanes-Oxley Act of 2002, during fiscal 2009.




We
believe we can cover any cash requirements with cost cutting or available
cash.  If we cannot cover any such cash shortfall with cost cutting or
available cash, we would need to obtain additional financing.  Due to
recent turmoil in global financial markets, we cannot be certain that any
financing will be available when needed or will be available on terms acceptable
to us.  If we raise equity capital our stockholders will be
diluted.  Insufficient funds may require us to delay, scale back or
eliminate some or all of our programs designed to facilitate the commercial
introduction of our systems or entry into new markets.




As of
August 31, 2008, we have no significant commitments for the purchase of property
and equipment.




We
believe that our current cash and cash equivalents, investments, income tax
refunds receivable, and expected cash provided from operating activities will be
sufficient to fund our operations for the next twelve months.  If the
global credit market continues to deteriorate, our investment portfolio may be
impacted and we could determine some of our investments have experienced
other-than-temporary declines in fair value, which could adversely impact our
financial results and decrease the amount of the investments available to fund
our operations.




The
Company has no off balance sheet arrangements as of August 31,
2008.




Recent Accounting
Pronouncements




On May 9, 2008, the FASB issued
Statement of Financial Accounting Standards (“SFAS”) No. 162, The Hierarchy of Generally Accepted
Accounting Principles.  This statement is intended to improve
financial reporting by identifying a consistent framework, or hierarchy, for
selecting accounting principles to be used in preparing financial statements in
conformity with U.S. generally accepted accounting principles (GAAP) for
nongovernmental entities.  The statement establishes that the GAAP
hierarchy should be directed to entities because it is the entity (not its
auditor) that is responsible for selecting accounting principles for financial
statements that are presented in conformity with GAAP.  This statement
is effective 60 days following the SEC’s approval of the Public Company
Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles.  We
do not believe the implementation of this statement will have a material impact
on our financial statements.





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In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities.  This statement changes the
disclosure requirements for derivative instruments and hedging
activities.  Entities are required to provide enhanced disclosures
about (a) how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows.  This
statement is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, or our fiscal year beginning
September 1, 2009, with early application encouraged.  This statement
encourages, but does not require, comparative disclosures for earlier periods at
initial adoption.  We currently are unable to determine what impact
the future application of this pronouncement may have on our financial
statements.





In
December 2007, the FASB issued SFAS No. 141(R) (revised 2007), Business
Combinations.  This statement replaces SFAS No. 141, Business Combinations and
applies to all transactions or other events in which an entity (the acquirer)
obtains control of one or more businesses (the acquiree), including those
sometimes referred to as “true mergers” or “mergers of equals” and combinations
achieved without the transfer of consideration.  This statement
establishes principles and requirements for how the acquirer: a) recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree; b)
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase; and c) determines what information to disclose to
enable users of the financials statements to evaluate the nature and financial
effects of the business combination.  This statement will be effective
for fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2008, or our fiscal year beginning September 1,
2009.  Earlier adoption is prohibited.  We currently are
unable to determine what impact the future application of this pronouncement may
have on our financial statements.





In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements.  This statement applies to
all entities that prepare consolidated financial statements, except
not-for-profit organizations, and amends Accounting Research Bulletin (“ARB”) 51
to establish accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary.  It also
amends certain of ARB 51’s consolidation procedures for consistency with the
requirements of SFAS No. 141 (revised 2007).  This statement will be
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008, or our fiscal year beginning September
1, 2009.  Earlier adoption is prohibited.  We currently are
unable to determine what impact the future application of this pronouncement may
have on our financial statements.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115. This statement permits entities to choose to measure many financial
instruments and certain other items at fair value.  Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option.  However, the amendment to SFAS No. 115 Accounting for Certain Investments
in Debt and Equity Securities applies to all entities with
available-for-sale and trading securities.  SFAS No. 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November
15, 2007.  We adopted SFAS No. 159 on September 1, 2008, with no
material impact on our financial statements.





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In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS
No. 157 defines fair value, establishes a framework for measuring fair value,
and requires enhanced disclosures about fair value measurements.  SFAS
No. 157 requires companies to disclose the fair value of their financial
instruments according to a fair value hierarchy as defined in the
standard.  Additionally, companies are required to provide enhanced
disclosure regarding financial instruments in one of the categories, including a
reconciliation of the beginning and ending balances separately for each major
category of assets and liabilities.  In February 2008, the FASB issued
FASB Staff Position (FSP) No. FAS 157-2, which delays by one year the effective
date of SFAS No. 157 for certain types of non-financial assets and non-financial
liabilities.  As a result, SFAS No. 157 will be effective for
financial statements issued for fiscal years beginning after November 15, 2007
for financial assets and liabilities carried at fair value on a recurring basis,
and for fiscal years beginning after November 15, 2008 for non-recurring
non-financial assets and liabilities that are recognized or disclosed at fair
value.  In October 2008, the FASB issued FSP No. 157-3,
Determining the Fair Value of
a Financial Asset When the Market for That Asset is Not Active, or FSP
157-3.  FSP 157-3 clarifies the application of SFAS 157 in a market that is
not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that
financial asset is not active.  FSP 157-3 was effective upon issuance,
including prior periods for which financial statements have not been
issued.




We
adopted SFAS No. 157 for financial assets and liabilities carried at fair value
on a recurring basis on September 1, 2008, with no material impact on our
financial statements.  We are currently unable to determine the impact
on our financial statements of the application of SFAS No. 157 on September 1,
2009, for non-recurring non-financial assets and liabilities that are recognized
or disclosed at fair value.


EITF No.
07-3, Accounting for
Nonrefundable Advance Payments for Goods or Services Received for Use in Future
Research and Development Activities,was issued in June
2007.  The EITF reached a consensus that nonrefundable payments for
goods and services that will be used or rendered for future research and
development activities should be deferred and capitalized.  Such
amounts should be recognized as an expense as the related goods are delivered
and the related services are performed.  Entities should continue to
evaluate whether they expect the goods to be delivered or services to be
rendered.  If the entity does not expect the goods to be delivered or
services to be rendered, the capitalized advance payment should be charged to
expense.  This pronouncement is effective for financial statements
issued for fiscal years beginning after December 15, 2007.  We adopted
EITF No. 07-3 on September 1, 2008, with no material impact our financial
statements.







FORWARD-LOOKING
STATEMENTS




With the
exception of historical facts, the statements contained in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and
“Business” are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, which reflect our current expectations
and beliefs regarding our future results of operations, performance and
achievements.  These statements are subject to risks and uncertainties
and are based upon assumptions and beliefs that may or may not
materialize.  These forward-looking statements include, but are not
limited to, statements concerning:




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 32




·
            our
      belief about the market opportunities for our products;·
            our
      anticipated financial performance and business plan;·
            our
      expectations regarding the commercialization of the BSD-2000, BSD 500 and
      MicroThermX-100 systems;·
            our
      expectations to further expand our developments to treat other diseases
      and medical conditions;·
            our
      expectations that in a higher production environment of established
      commercial sales we could achieve a 60% gross margin on system sales and
      an 80% gross margin on service agreements and disposable applicators used
      with our MicroThermX-100 system;·
            our
      belief concerning the market potential for developed cancer therapy
      systems;·
            our
      expectations related to the after-market opportunity for service
      agreements;·
            our
      expectations related to the replacement cycle for our
    systems;·
            our
      expectations that we will incur increased expenses related to seeking
      governmental and regulatory approvals for our products;·
            our
      expectations and efforts regarding FDA approvals relating to the BSD-2000
      system;·
            our
      belief that our technology has application for additional approaches to
      treating cancer and for other medical purposes;·
            our
      expectations related to the amount of expenses we will incur for the
      commercial introduction of the BSD-2000 and MicroThermX-100
      systems;·
            our
      expectation that we will incur increased expenses related to our corporate
      governance and compliance with the Sarbanes-Oxley Act of
    2002;·
            our
      expectation that our selling, general and administrative expenses will
      continue at similar levels at least in the short term;·
            our
      belief that as sales volume increases, we will more fully absorb our fixed
      overhead costs;·
            our
      belief that we can cover any cash shortfall with cost cutting or available
      cash; and·
            our
      belief that our current working capital, investments and cash from
      operations will be sufficient to finance our operations through working
      capital and capital resources needs for the next twelve
      months.




We wish
to caution readers that the forward-looking statements and our operating results
are subject to various risks and uncertainties that could cause our actual
results and outcomes to differ materially from those discussed or anticipated,
including the factors set forth in Item 1A – “Risk Factors” and our other
filings with the Securities and Exchange Commission.  We also wish to
advise readers not to place any undue reliance on the forward-looking statements
contained in this report, which reflect our beliefs and expectations only as of
the date of this report.  We assume no obligation to update or revise
these forward-looking statements to reflect new events or circumstances or any
changes in our beliefs or expectations, other than as required by
law.








ITEM
7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





A
significant portion of the Company’s cash equivalents and short-term investments
bear variable interest rates that are adjusted to market
conditions.  Changes in financial market conditions and in market
rates will affect interest and investment income earned and potentially the
market value of the principal of these instruments.  The Company does
not utilize derivative instruments to offset the exposure to interest rate
changes.  Significant changes in interest rates may have a material
impact on the Company’s results of operations.





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 33


The Company does have significant sales
to foreign customers and is therefore subject to the effects of changes in
foreign currency exchange rates may have on demand for its products and
services. The Company does not utilize derivative instruments to offset the
exposure to changes in foreign currency exchange rates.  To minimize
foreign exchange risk, the Company’s export sales are transacted in United
States dollars.








ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA





The
Financial Statements of the Company called for by this item are contained in a
separate section of this report.  See “Index to Financial Statements”
on Page F-1.








ITEM
9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL
DISCLOSURES





None.








ITEM
9A.  CONTROLS AND PROCEDURES





Disclosure
Controls and Procedures




The
Company intends to maintain disclosure controls and procedures designed to
provide reasonable assurance that information required to be disclosed in
reports filed under the Securities Exchange Act of 1934 (the “Act”) is recorded,
processed, summarized and reported within the specified time periods and
accumulated and communicated to management, including its Chief Executive
Officer (Principal Executive Officer) and Chief Financial Officer (Principal
Accounting Officer), as appropriate, to allow timely decisions regarding
required disclosure.




Management,
under the supervision and with the participation of its Chief Executive Officer
(Principal Executive Officer) and Chief Financial Officer (Principal Accounting
Officer), evaluated the effectiveness of the Company’s disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d-15(e) promulgated under
the Act), as of August 31, 2008.  Based on that evaluation, management
concluded that our disclosure controls and procedures were effective as of
August 31, 2008.





Attached
as exhibits to this Annual Report on Form 10-K are certifications of the
Company’s Chief Executive Officer (Principal Executive Officer) and Chief
Financial Officer (Principal Accounting Officer), which are required in
accordance with Rule 13a-14 of the Act.  This Disclosure Controls
and Procedures section includes information concerning management’s evaluation
of disclosure controls and procedures referred to in those certifications and,
as such, should be read in conjunction with the certifications of the Company’s
Chief Executive Officer (Principal Executive Officer) and Chief Financial
Officer (Principal Accounting Officer).





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 34





Management’s
Report on Internal Control Over Financial Reporting





Management
is responsible for establishing and maintaining adequate internal control over
financial reporting of the Company.  Management’s intent is to design
this system to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles in the
United States of America.





The
Company’s internal control over financial reporting includes those policies and
procedures that:





1.
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;2.
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with GAAP, and that
      receipts and expenditures of the Company are being made only in accordance
      with authorizations of management and directors of the Company;
      and3.
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use, or disposition of the Company’s assets that
      could have a material effect on the financial
  statements.





A
material weakness is a significant deficiency, or combination of significant
deficiencies, in internal controls over financial reporting such that there is a
reasonable possibility that a material misstatement of the annual or interim
financial statements will not be prevented or detected on a timely
basis.  Management performed an assessment of the effectiveness of the
Company’s internal control over financial reporting as of August 31, 2008,
utilizing the criteria described in the “Internal Control — Integrated
Framework” issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”).  The objective of this assessment was to
determine whether the Company’s internal control over financial reporting was
effective as of such date.  In its assessment of the effectiveness of
internal control over financial reporting as of August 31, 2008, management
concluded that our internal control over financial reporting is effective to
ensure that information required to be disclosed by us in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms.





Management’s
assessment of the effectiveness of the Company’s internal control over financial
reporting has been audited by Tanner LC, an independent registered public
accounting firm, as stated in their report which is included
herein.





Changes
in Internal Control Over Financial Reporting





There
have been no changes in the Company’s internal control over financial reporting
that have materially affected, or are reasonably likely to materially affect,
the Company’s internal control over financial reporting.





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 35


Limitations
on the Effectiveness of Controls





Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls or our internal controls will
prevent or detect all errors and all fraud.  A control system, no
matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control system’s objectives will be
met.  Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs.  Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake.  Controls can also be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the controls.  The design of any
system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future
conditions.  Over time, controls may become inadequate because of
changes in conditions or deterioration in the degree of compliance with
associated policies or procedures.  Because of the inherent
limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.








ITEM
9B.  OTHER INFORMATION





None.








PART
III





ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





Information
required by this item is incorporated by reference from the information in the
Company’s definitive Proxy Statement to be filed for the 2009 Annual Meeting of
Stockholders.








ITEM 11.
EXECUTIVE COMPENSATION





Information
required by this item is incorporated by reference from the information in the
Company’s definitive Proxy Statement to be filed for the 2009 Annual Meeting of
Stockholders.








ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS





Information
required by this item is incorporated by reference from the information in the
Company’s definitive Proxy Statement to be filed for the 2009 Annual Meeting of
Stockholders.








ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE





The
information required by this item is incorporated by reference from the
information in the Company’s definitive Proxy Statement to be filed for the 2009
Annual Meeting of Stockholders.


ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
 Information
required by this item is incorporated by reference from the information in the
Company’s definitive Proxy Statement to be filed for the 2009 Annual Meeting of
Stockholders.


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 36




PART
IV




ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES




(a)(1)
              Financial
      StatementsThe Index to Financial Statements on page F-1 is incorporated herein by
      reference as the list of financial statements required as part of this
      report.(2)
              Financial
      Statement SchedulesFinancial statement schedules have been omitted because they are not
      required or are not applicable, or because the required information is
      shown in the financial statements or notes thereto.(3)
              ExhibitsThe
      following exhibits are incorporated herein by reference as
      indicated:


Exhibit
      Number
            Description3.1
            Amended
      and Restated Certificate of Incorporation.  Incorporated by
      reference to Exhibit 3.1 of the BSD Medical Corporation Annual Report Form
      10-KSB, filed December 1, 2003.3.2
            By-Laws.  Incorporated
      by reference to Exhibit 3.2 of the BSD Medical Corporation Registration
      Statement on Form S-1, filed October 16, 1986.3.3
            Amendment
      to Bylaws.  Incorporated by reference to Exhibit 3.1 of Current
      Report on Form 8-K filed January 4, 2008.4.1
            Specimen
      Common Stock Certificate.  Incorporated by reference to Exhibit
      4 of the BSD Medical Corporation Registration Statement on Form S-1, filed
      October 16, 1986.4.2
            Emerson
      Securities Purchase Agreement.  Incorporated by reference to
      Exhibit 4.1 of the BSD Medical Corporation Annual Report on Form 10-KSB,
      filed December 1, 2003.10.1
            Transfer
      of Trade Secrets Agreement dated December 7, 1979, among BSD Medical
      Corporation, Vitek, Incorporated and Ronald R.
      Bowman.  Incorporated by reference to Exhibit 10.6 of the BSD
      Medical Corporation Registration Statement on Form S-1, filed October 16,
      1986.10.2
            Second
      Addendum to Exclusive Transfer of Trade Secrets Agreement dated April 2,
      1987.  Incorporated by reference to Exhibit 10 of the BSD
      Medical Corporation Annual Report on Form 10-K, filed April 8,
      1988.10.3
            License
      Agreement between BSD Medical Corporation and EDAP Technomed, Inc., dated
      July 3, 1996.  Incorporated by reference to Exhibit 10 of
      Current Report on Form 8-K, filed August 7, 1996.10.4
            Stock
      Purchase Agreement dated October 31, 1997, by and among TherMatrx, Inc.,
      BSD Medical Corporation, Oracle Strategic Partners, L.P. and Charles
      Manker.  Incorporated by reference to Exhibit 10.6 of the BSD
      Medical Corporation Annual Report on Form 10-KSB filed December 10,
      1998.10.5*
            BSD
      Medical Corporation 1998 Director Stock Plan.  Incorporated by
      reference to Exhibit A of the BSD Medical Corporation Schedule 14A, filed
      July 27, 1998.10.6*
            BSD
      Medical Corporation 1998 Stock Incentive Plan.  Incorporated by
      reference to Exhibit B of the BSD Medical Corporation Schedule 14B, filed
      July 27, 1998.10.7*
            BSD Medical Corporation Form of Employee
      Stock Option Grant10.8*
            BSD Medical Corporation Form of Director
      Stock Option Grant10.9*
            Employment
      Agreement dated August 10, 1999 between BSD Medical Corporation and Hyrum
      A. Mead.  Incorporated by reference to Exhibit 10.7 to BSD
      Medical Corporation’s Registration Statement on Form SB-2 filed January
      27, 2004.




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10.10*
            Employment
      Agreement dated November 2, 2008 between BSD Medical Corporation and Paul
      F. Turner.  Incorporated by reference to Exhibit 10.8 to BSD
      Medical Corporation’s Registration Statement on Form SB-2 filed January
      27, 2004.21.1
            Subsidiary
      List.  Incorporated by reference to Exhibit 21.1 of the BSD
      Medical Corporation Annual Report on Form 10-KSB filed December 1,
      2003.23.1
            Consent of Independent Registered Public
      Accounting Firm31.1
            Certification of Chief Executive Officer of
      BSD pursuant to Rule 13a-14.31.2
            Certification of Chief Financial Officer of
      BSD pursuant to Rule 13a-14.32.1
            Certification of Chief Executive Officer
      attached pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes Oxley Act of 2002.32.2
            Certification of the Chief Financial Officer
      of BSD pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.





*
Exhibits marked with an asterisk (*) are management contracts or compensatory
plans or arrangements.


Return to Table of Contents
 38


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.







BSD
MEDICAL CORPORATION





Date:  November
      14, 2008
            By:/s/
      Hyrum A.
      MeadHyrum
      A. MeadPresident
      and Member of the Board of Directors(principal
      executive officer)





Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.





Date:  November
      14, 2008
            By:
            /s/ Paul F.
      TurnerPaul
      F. TurnerChairman
      of the Board, Senior Vice President and Chief Technology
      OfficerDate:  November
      14, 2008
            By:
            /s/ Hyrum A.
      MeadHyrum
      A. MeadPresident
      and Member of the Board of Directors (principal executive
      officer)Date:  November
      14, 2008
            By:
            /s/ Dennis P.
      GaugerDennis
      P. GaugerChief
      Financial Officer (principal financial and accounting
    officer)Date:  November
      14, 2008
            By:
            /s/ Gerhard W.
      SennewaldDr.
      Gerhard W. SennewaldMember
      of the Board of DirectorsDate:  November
      14, 2008
            By:
            /s/ Steven G.
      StewartSteven
      G. StewartMember
      of the Board of DirectorsDate:  November
      14, 2008
            By:
            /s/ Michael
      NobelDr.
      Michael NobelMember
      of the Board of DirectorsDate:  November
      14, 2008
            By:
            /s/
      Douglas P.
      BoydDr.
      Douglas P. BoydMember
      of the Board of DirectorsDate:  November
      14, 2008
            By:
            /s/
      Timothy C.
      McQuayTimothy
      C. McQuayMember
      of the Board of Directors





Return to Table of Contents
 39





BSD MEDICAL CORPORATION


Index
to Financial Statements








Report
      of Independent Registered Public Accounting Firm on Internal
      Control Over Financial Reporting
            F-2Report
      of Independent Registered Public Accounting Firm
            F-4Balance
      Sheets
            F-5Statements
      of Operations
            F-6Statements
      of Stockholders’ Equity
            F-7Statements
      of Cash Flows
            F-8Notes
      to Financial Statements
            F-9





Return to Table of Contents
 F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER
FINANCIAL REPORTING




To the
Board of Directors and Stockholders
 of
BSD Medical Corporation





We have
audited the internal control of BSD Medical Corporation (the Company) over
financial reporting as of August 31, 2008 and 2007, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the COSO criteria). The
Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management’s
Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company’s internal control over financial reporting
based on our audit.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.




A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with U.S. generally accepted accounting principles. A company's internal control
over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with U.S. generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management and
directors of the Company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the Company's assets that could have a material effect on the financial
statements. Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.





In our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of August 31, 2008 and 2007, based on the
COSO criteria.


Return to Table of Contents
 F-2




We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the balance sheets of the Company as of August
31, 2008 and 2007, and the related statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended
August 31, 2008, and our report dated November 14, 2008 expressed an unqualified
opinion thereon.








/s/
TANNER LC





Salt Lake
City, Utah


November
14, 2008


Return to Table of Contents
 F-3




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM











To the
Board of Directors and Stockholders


of
BSD Medical Corporation








We have
audited the accompanying balance sheets of BSD Medical Corporation as of August
31, 2008 and 2007, and the related statements of operations, stockholders’
equity and cash flows for each of the years in the three-year period ended
August 31, 2008.  These financial statements are the responsibility of
the Company's management.  Our responsibility is to express an opinion
on these financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of BSD Medical Corporation as of
August 31, 2008 and 2007, and the results of its operations and its cash flows
for each of the years in the three-year period ended August 31, 2008, in
conformity with U.S. generally accepted accounting principles.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of BSD Medical Corporation’s
internal control over financial reporting as of August 31, 2008, based on
criteria established in Internal Control−Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated November 14, 2008 expressed an unqualified opinion thereon.








/s/
TANNER LC





Salt Lake
City, Utah


November
14, 2008


Return to Table of Contents
 F-4





BSD
      MEDICAL CORPORATIONBalance
      SheetsAugust
      31,ASSETS
            
            2008
            
            
            2007Current
      assets:Cash
      and cash equivalents
            
            $
            1,394,652
            
            
            $
            416,540Investments
            
            
            14,487,192
            
            
            
            19,090,118Accounts
      receivable, net of allowance for doubtfulaccounts of $20,000
            
            
            439,739
            
            
            
            203,267Related
      party trade accounts receivable
            
            
            737,483
            
            
            
            488,200Income
      tax receivable
            
            
            1,409,996
            
            
            
            1,759,995Inventories,
      net
            
            
            1,425,153
            
            
            
            1,510,067Other
      current assets
            
            
            113,829
            
            
            
            127,003Deferred
      tax asset
            
            
            -
            
            
            
            387,000Total
      current assets
            
            
            20,008,044
            
            
            
            23,982,190Property
      and equipment, net
            
            
            1,441,524
            
            
            
            271,077Patents,
      net
            
            
            37,330
            
            
            
            19,373Deferred
      tax asset
            
            
            -
            
            
            
            69,000$
            21,486,898
            
            
            $
            24,341,640LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            221,605
            
            
            $
            235,676Accrued
      liabilities
            
            
            585,777
            
            
            
            633,090Customer
      deposits
            
            
            427,677
            
            
            
            214,638Deferred
      revenue – current portion
            
            
            41,885
            
            
            
            26,115Total
      current liabilities
            
            
            1,276,944
            
            
            
            1,109,519Deferred
      revenue – net of current portion
            
            
            54,094
            
            
            
            48,333Total
      liabilities
            
            
            1,331,038
            
            
            
            1,157,852Commitments
      and contingenciesStockholders’
      equity:Preferred
      stock, $.001 par value; 10,000,000 sharesauthorized, no shares issued and outstanding
            
            
            -
            
            
            
            -Common
      stock; $.001 par value, 40,000,000 sharesauthorized, 21,388,958 and 21,297,446 shares issued,respectively
            
            
            21,389
            
            
            
            21,298Additional
      paid-in capital
            
            
            27,565,373
            
            
            
            26,373,637Treasury
      stock, 24,331 shares at cost
            
            
            (234
            )
            
            
            (234
            )Other
      comprehensive loss
            
            
            (2,141,416
            )
            
            
            (360,760
            )Accumulated
      deficit
            
            
            (5,289,252
            )
            
            
            (2,850,153
            )Total
      stockholders’ equity
            
            
            20,155,860
            
            
            
            23,183,788$
            21,486,898
            
            
            $
            24,341,640See
      accompanying notes to financial statements





Return to Table of Contents
 F-5




BSD
      MEDICAL CORPORATIONStatements
      of OperationsYears
      Ended August 31,2008
            
            
            2007
            
            
            2006Revenues:Sales
            
            $
            2,334,008
            
            
            $
            1,449,054
            
            
            $
            2,209,316Sales
      to related parties
            
            
            2,809,132
            
            
            
            1,385,332
            
            
            
            689,086Total
      revenues
            
            
            5,143,140
            
            
            
            2,834,386
            
            
            
            2,898,402Operating
      costs and expenses:Cost
      of sales
            
            
            956,220
            
            
            
            766,040
            
            
            
            1,399,426Cost
      of related party sales
            
            
            1,128,029
            
            
            
            815,522
            
            
            
            317,214Research
      and development
            
            
            1,737,924
            
            
            
            1,875,147
            
            
            
            1,251,956Selling,
      general and administrative
            
            
            5,573,311
            
            
            
            5,762,217
            
            
            
            5,028,957Total
      operating costs and expenses
            
            
            9,395,484
            
            
            
            9,218,926
            
            
            
            7,997,553Loss
      from operations
            
            
            (4,252,344
            )
            
            
            (6,384,540
            )
            
            
            (5,099,151
            )Other
      income (expense):Interest
      and investment income
            
            
            1,046,313
            
            
            
            1,133,125
            
            
            
            1,301,341Other
            
            
            (194,068
            )
            
            
            (164,003
            )
            
            
            240,034Gain
      on sale of equity interest
            
            
            -
            
            
            
            202,223
            
            
            
            18,016,272Total
      other income (expense)
            
            
            852,245
            
            
            
            1,171,345
            
            
            
            19,557,647Income
      (loss) before income taxes
            
            
            (3,400,099
            )
            
            
            (5,213,195
            )
            
            
            14,458,496Income
      tax (provision) benefit
            
            
            961,000
            
            
            
            1,865,000
            
            
            
            (5,209,000
            )Net
      income (loss)
            
            $
            (2,439,099
            )
            
            $
            (3,348,195
            )
            
            $
            9,249,496Income
      (loss) per common share:Basic
            
            $
            (0.11
            )
            
            $
            (0.16
            )
            
            $
            0.45Diluted
            
            $
            (0.11
            )
            
            $
            (0.16
            )
            
            $
            0.42Weighted
      average number of sharesoutstanding:Basic
            
            
            21,339,000
            
            
            
            21,125,000
            
            
            
            20,766,000Diluted
            
            
            21,339,000
            
            
            
            21,125,000
            
            
            
            22,174,000See
      accompanying notes to financial statements




Return to Table of Contents
 F-6





BSD
      MEDICAL CORPORATIONStatements
      of Stockholders’ EquityYears
      Ended August 31, 2008, 2007 and 2006Common
      Stock
            
            
            Additional
              Paid-in
              Capital
            
            
            Deferred
              Compensation
            
            
            Treasury
      Stock
            
            
            Other
              Comprehensive
              Income (Loss)
            
            
            Retained
              Earnings
              (Accumulated
              Deficit)
            
            
            TotalShares
            
            
            Amount
            
            
            Shares
            
            
            AmountBalance,
      August 31, 2005
            
            
            20,365,070
            
            
            $
            20,365
            
            
            $
            23,706,101
            
            
            $
            (34,050
            )
            
            
            24,331
            
            
            $
            (234
            )
            
            $
            36,939
            
            
            $
            (8,751,454
            )
            
            $
            14,977,667Common
      stock issued for:Cash
            
            
            644,991
            
            
            
            645
            
            
            
            423,691
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            424,336Services
            
            
            13,607
            
            
            
            14
            
            
            
            48,457
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            48,471Income
      tax benefit from exercise
              of
      stock options
            
            
            -
            
            
            
            -
            
            
            
            972,282
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            972,282Amortization
      of deferred
              compensation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            88,050
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            88,050Decrease
      in other comprehensive
              income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (136,301
            )
            
            
            -
            
            
            
            (136,301
            )Deferred
      compensation
            
            
            -
            
            
            
            -
            
            
            
            301,700
            
            
            
            (301,700
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            9,249,496
            
            
            
            9,249,496Balance,
      August 31, 2006
            
            
            21,023,668
            
            
            
            21,024
            
            
            
            25,452,231
            
            
            
            (247,700
            )
            
            
            24,331
            
            
            
            (234
            )
            
            
            (99,362
            )
            
            
            498,042
            
            
            
            25,624,001Close
      out deferred compensation
            
            
            -
            
            
            
            -
            
            
            
            (247,700
            )
            
            
            247,700
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Common
      stock issued for:Cash
            
            
            195,933
            
            
            
            196
            
            
            
            229,511
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            229,707Services
            
            
            10,288
            
            
            
            10
            
            
            
            59,990
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            60,000Cashless option exercises
            
            
            67,557
            
            
            
            68
            
            
            
            (68
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stock-based
      compensation
            
            
            -
            
            
            
            -
            
            
            
            832,224
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            832,224Income
      tax benefit from exercise
              of
      stock options
            
            
            -
            
            
            
            -
            
            
            
            47,449
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            47,449Increase
      in other comprehensive
              loss,
      net of income tax benefit
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (261,398
            )
            
            
            -
            
            
            
            (261,398
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (3,348,195
            )
            
            
            (3,348,195
            )Balance,
      August 31, 2007
            
            
            21,297,446
            
            
            
            21,298
            
            
            
            26,373,637
            
            
            
            -
            
            
            
            24,331
            
            
            
            (234
            )
            
            
            (360,760
            )
            
            
            (2,850,153
            )
            
            
            23,183,788Common
      stock issued for:Cash
            
            
            56,499
            
            
            
            56
            
            
            
            158,426
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            158,482Services
            
            
            10,514
            
            
            
            11
            
            
            
            61,184
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            61.195Cashless
      option exercises
            
            
            24,499
            
            
            
            24
            
            
            
            (24
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Stock-based
      compensation
            
            
            -
            
            
            
            -
            
            
            
            800,432
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            800,432Income
      tax benefit from exercise
              of
      stock options
            
            
            -
            
            
            
            -
            
            
            
            171,718
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            171,718Increase
      in other comprehensive
              loss,
      net of income tax benefit
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,780,656
            )
            
            
            -
            
            
            
            (1,780,656
            )Net
      loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (2,439,099
            )
            
            
            (2,439,099
            )Balance,
      August 31, 2008
            
            
            21,388,958
            
            
            $
            21,389
            
            
            $
            27,565,373
            
            
            $
            -
            
            
            
            24,331
            
            
            $
            (234
            )
            
            $
            (2,141,416
            )
            
            $
            (5,289,252
            )
            
            $
            20,155,860See
      accompanying notes to financial statements




Return to Table of Contents
 F-7





BSD
      MEDICAL CORPORATIONStatements
      of Cash FlowsYears
      Ended August 31,2008
            
            
            2007
            
            
            2006Cash
      flows from operating activities:Net
      income (loss)
            
            $
            (2,439,099
            )
            
            $
            (3,348,195
            )
            
            $
            9,249,496Adjustments
      to reconcile net income (loss) to netcash used in operating activities:Depreciation
      and amortization
            
            
            120,216
            
            
            
            97,849
            
            
            
            86,860Loss
      (gain) on disposition of property
            
            
            3,444
            
            
            
            2,597
            
            
            
            -Stock
      issued for services
            
            
            61,195
            
            
            
            60,000
            
            
            
            48,471Stock-based
      compensation
            
            
            800,432
            
            
            
            832,224
            
            
            
            -Provision
      for doubtful accounts
            
            
            -
            
            
            
            -
            
            
            
            (22,500
            )Gain
      on sale of equity interest
            
            
            -
            
            
            
            (202,223
            )
            
            
            (18,016,272
            )Amortization
      of deferred compensation
            
            
            -
            
            
            
            -
            
            
            
            88,050Decrease
      (increase) in:Receivables
            
            
            (485,755
            )
            
            
            894,376
            
            
            
            (922,163
            )Note
      receivable
            
            
            -
            
            
            
            -
            
            
            
            (137,500
            )Income
      tax receivable
            
            
            521,717
            
            
            
            (1,752,492
            )
            
            
            -Inventories
            
            
            84,914
            
            
            
            (143,803
            )
            
            
            (231,911
            )Deferred
      tax asset
            
            
            244,000
            
            
            
            (66,000
            )
            
            
            (74,000
            )Other
      current assets
            
            
            13,174
            
            
            
            (6,726
            )
            
            
            12,464Increase
      (decrease) in:Accounts
      payable
            
            
            (14,071
            )
            
            
            (129,720
            )
            
            
            252,583Accrued
      liabilities
            
            
            (47,313
            )
            
            
            187,977
            
            
            
            296,737Customer
      deposits
            
            
            213,039
            
            
            
            114,638
            
            
            
            -Income
      taxes payable
            
            
            -
            
            
            
            (1,500,000
            )
            
            
            2,271,469Deferred
      revenue
            
            
            -
            
            
            
            (160,964
            )
            
            
            228,084Deferred
      tax liability
            
            
            21,531
            
            
            
            -
            
            
            
            (13,000
            )Net
      cash used in operating activities
            
            
            (902,576
            )
            
            
            (5,120,462
            )
            
            
            (6,883,132
            )Cash
      flows from investing activities:Sale
      (purchase) of investments
            
            
            3,034,270
            
            
            
            2,992,590
            
            
            
            (10,073,884
            )Purchase
      of property and equipment
            
            
            (1,291,098
            )
            
            
            (66,612
            )
            
            
            (213,172
            )Purchase
      of patents
            
            
            (20,966
            )
            
            
            -
            
            
            
            -Proceeds
      from sale equity interest
            
            
            -
            
            
            
            202,223
            
            
            
            18,016,272Net
      cash provided by investing activities
            
            
            1,722,206
            
            
            
            3,128,201
            
            
            
            7,729,216Cash
      flows from financing activities:Proceeds
      from the sale of common stock
            
            
            158,482
            
            
            
            229,707
            
            
            
            424,336Net
      increase (decrease) in cash and cash equivalents
            
            
            978,112
            
            
            
            (1,762,554
            )
            
            
            1,270,420Cash
      and cash equivalents, beginning of year
            
            
            416,540
            
            
            
            2,179,094
            
            
            
            908,674Cash
      and cash equivalents, end of year
            
            $
            1,394,652
            
            
            $
            416,540
            
            
            $
            2,179,094See
      accompanying notes to financial statements




Return to Table of Contents
 F-8


BSD
MEDICAL CORPORATION


Notes
to Financial Statements








Note
1:  Organization and Significant Accounting Policies





Organization – BSD Medical
Corporation (the Company) was incorporated in the State of Delaware on July 3,
1986.  The Company develops, produces, markets, and services systems
used for the treatment of cancer and other diseases.  These systems
are sold worldwide. The Company’s operations are considered to comprise one
business segment.





Cash and Cash Equivalents –
Cash and cash equivalents consist of cash and investments with original
maturities to the Company of three months or less.





Investments – Investments with
scheduled maturities greater than three months, but not greater than one year,
are recorded as short-term investments.  Management classified these
investments at August 31, 2008 and 2007 as available-for sale.  The
short-term investments are recorded at fair value, with net unrealized gains and
losses reported as other comprehensive income in the statements of stockholders’
equity, net of income taxes.  Realized gains and losses are included
in the statements of income.





Trade Accounts Receivable –
Trade accounts receivable are carried at original invoice amount less an
estimate made for doubtful receivables based on a review of all outstanding
amounts on a monthly basis. Management estimates an allowance for doubtful
accounts by identifying troubled accounts and by using historical experience
applied to an aging of accounts. Trade accounts receivable are written off when
deemed uncollectible. Recoveries of trade receivables previously written off are
recorded when received. Interest is not charged on trade receivables that are
outstanding beyond their due date.





Inventories –Parts and
supplies inventories are stated at the lower of cost or market.  Cost
is determined using the average cost method.  Work-in-process and
finished goods are stated at the lower of the accumulated manufacturing costs or
market.  Provisions, when required, are made to reduce excess and
obsolete inventories to their estimated net realizable value.  The
provision was $40,000 at August 31, 2008 and 2007.





Property and Equipment –
Property and equipment are stated at cost less accumulated
depreciation.  Depreciation is determined using the straight-line
method over the following estimated useful lives of the assets.





Equipment
            2 –
      5 yearsFurniture
      and fixtures
            5
      yearsBuilding
      improvements
            15
      yearsBuilding
            40
      years





Expenditures for maintenance and
repairs are expensed when incurred and betterments are
capitalized.  Gains and losses on sales of property and equipment are
reflected in operations.





Maintenance and repairs are charged to
costs and expenses as incurred.  The cost and accumulated depreciation
of property and equipment sold or otherwise retired are removed from the
accounts and any related gain or loss on disposition is reflected in net income
or loss for the period.





Return to Table of Contents
 F-9


Patents – Patents are carried
at cost and are being amortized over 17 years.





Warranty Reserve – The Company
provides limited warranties to its customers for products
sold.  Estimated future warranty obligations are accrued each
period.  As of August 31, 2008 and 2007, the accrued warranty reserve
was $22,640 and $30,614, respectively.  During the fiscal years ended
August 31, 2008, 2007, and 2006, total warranty expense was $68,470,
$38,519 and $24,763, respectively.





Income Taxes–The Company accounts for
income taxes using the asset and liability method.  Under the asset
and liability method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases.  Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.





Income Per Common Share– The computation of basic
income (loss) per common share is based on the weighted average number of shares
outstanding during each year.





The computation of diluted earnings per
common share is based on the weighted average number of shares outstanding
during the year, plus the common stock equivalents that would arise from the
exercise of stock options and warrants outstanding, using the treasury stock
method and the average market price per share during the year.  Common
stock equivalents are not included in the diluted loss per share calculation
when their effect is anti-dilutive.  Options to purchase 2,182,629,
1,795,853 and 1,809,051 shares of common stock at prices ranging from $0.37 to
$6.50, $0.37 to $5.76, and $0.37 to $5.76 per share were outstanding at
August 31, 2008, 2007 and 2006, respectively.





The shares used in the computation of
the Company’s basic and diluted earnings per share are reconciled as
follows:





Years
      Ended August 31,2008
            
            
            2007
            
            
            2006Weighted
      average number ofshares outstanding – basic
            
            
            21,339,000
            
            
            
            21,125,000
            
            
            
            20,766,000Dilutive
      effect of stock options
            
            
            -
            
            
            
            -
            
            
            
            1,408,000Weighted
      average number ofshares outstanding, assuming dilution
            
            
            21,339,000
            
            
            
            21,125,000
            
            
            
            22,174,000





Return to Table of Contents
 F-10


Stock-Based Compensation -Effective September 1, 2006, the Company adopted the fair value
recognition provisions of Statement of Financial Accounting Standards (SFAS)
No. 123(R), Share Based
Payments, using the modified prospective application
method.  Under this transition method, the Company recorded
compensation expense on a straight-line basis of $800,432 and $832,224 for the
years ended August 31, 2008 and 2007, respectively for: (a) the vesting of
options granted prior to September 1, 2006 (based on the grant-date fair value
estimated using the Black-Scholes option-pricing model and previously presented
in the pro-forma footnote disclosures), and (b) stock-based awards granted
subsequent to August 31, 2006 (based on the grant-date fair value estimated
using the Black-Scholes option pricing model).  In accordance with the
modified prospective application method, results for the year ended August 31,
2006 have not been restated.





Prior to the fiscal year ended August
31, 2007, the Company accounted for stock options granted to employees under the
recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations, and adopted the disclosure-only
provisions of SFAS No. 123, Accounting for Stock-Based
Compensation.  Accordingly, compensation costs are recognized
in the financial statements for the year ended August 31, 2006 for options
granted with an exercise price less than the market value of the underlying
common stock on the date of grant.  During the year ended August 31,
2006, the Company recognized $88,050 related to stock options granted to
employees with an exercise price less than the market value of the underlying
common stock.  Had the Company’s options been determined based on the
fair value method, the results of operations for the year ended August 31, 2006
would have been reduced to the pro forma amounts indicated below:


Net
      income as reported
            
            $
            9,249,496Add:  Stock-based
      employee compensation expenseincluded in reported net income, net of related tax
effects
            
            
            88,050Deduct:  Total
      stock-based employee compensationexpense determined under fair value basedmethod for all awards, net of related tax effects
            
            
            (749,586
            )Net
      income – pro forma
            
            $
            8,587,960Earnings
      per share:Basic
      – as reported
            
            $
            0.45Basic
      – pro forma
            
            $
            0.41Diluted
      – as reported
            
            $
            0.42Diluted
      – pro forma
            
            $
            0.39




Revenue Recognition – The
Company recognizes revenue from the sale of cancer treatment systems, the sale
of parts and accessories related to the cancer treatment systems, providing
manufacturing services, providing training, and service support
contracts.  Product sales were $4,841,713, $2,520,818 and $2,706,214
for the years ended August 31, 2008, 2007and 2006,
respectively.  Service and other revenues were $301,427, $313,568 and
$192,188 for the years ended August 31, 2008, 2007 and 2006,
respectively.





Return to Table of Contents
 F-11


Revenue
from the sale of cancer treatment systems is recognized when a purchase order
has been received, the system has been shipped, the selling price is fixed or
determinable, and collection is reasonably assured.  Most system sales
are F.O.B. shipping point, therefore shipment is deemed to have occurred when
the product is delivered to the transportation carrier.  Most system
sales do not include installation.  If installation is included as
part of the contract, revenue is not recognized until installation has occurred,
or until any remaining installation obligation is deemed to be
perfunctory.  Some sales of cancer treatment systems may include
training as part of the sale.  In such cases, the portion of the
revenue related to the training, calculated based on the amount charged for
training on a stand-alone basis, is deferred and recognized when the training
has been provided.  The sales of the Company’s cancer treatment
systems do not require specific customer acceptance provisions and do not
include the right of return except in cases where the product does not function
as guaranteed by the Company.  The Company provides a reserve
allowance for estimated returns.  To date, returns have not been
significant.





Revenue
from manufacturing services is recorded when an agreement with the customer
exists for such services, the services have been provided, and collection is
reasonably assured.





Revenue
from training services is recorded when an agreement with the customer exists
for such training, the training services have been provided, and collection is
reasonably assured.





Revenue
from service support contracts is recognized on a straight-line basis over the
term of the contract, which approximates recognizing it as it is
earned.





The
Company’s revenue recognition policy is the same for sales to both related
parties and non-related parties.  The Company provides the same
products and services under the same terms for non-related parties as with
related parties.





Sales to
distributors are recognized in the same manner as sales to end-user
customers.





Deferred
revenue and customer deposits payable include amounts from service contracts as
well as cash received for the sales of products, which have not been
shipped.





Concentration of Credit Risk –
Financial instruments that potentially subject the Company to concentration of
credit risk consists primarily of trade receivables.  In the normal
course of business, the Company provides credit terms to its
customers.  Accordingly, the Company performs ongoing credit
evaluations of its customers and maintains allowances for possible
losses.





The
Company has cash in the bank and short-term investments that exceed federally
insured limits.  The Company has not experienced any losses in such
accounts.





Advertising and Promotion –Advertising and promotion costs, which are principally included in sales
expenses, are expensed as incurred.  Advertising and promotion expense
was approximately $206,493, $331,000 and $758,000 for the years ended August 31,
2008, 2007 and 2006, respectively.





Use of Estimates in the Preparation
of Financial Statements – The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period.  Actual results
could differ from those estimates.





Return to Table of Contents
 F-12


Comprehensive Income (Loss) –
Comprehensive income (loss) consists of net income and net unrealized gains and
losses from the Company’s investments classified as available-for sale, which is
reported on the accompanying statements of stockholders’ equity as a component
of other comprehensive income.  Comprehensive loss for the years ended
August 31, 2008 and 2007 was $4,219,755 and $3,609,593,
respectively.  Comprehensive income for the year ended August 31, 2006
was $9,113,195.





Reclassifications – Certain
amounts in the prior years have been reclassified to conform with the current
year presentation.








Note
2:  Detail of Certain Balance Sheet Accounts





Details of certain balance sheet
accounts are as follows:





August
      31,Accounts
      receivable:
            
            2008
            
            
            2007Trade
      receivables – non-related party
            
            $
            407,528
            
            
            $
            113,493Other
      receivables
            
            
            8,305
            
            
            
            6,638Accrued
      interest receivable
            
            
            43,906
            
            
            
            103,136Allowance
      for doubtful accounts
            
            
            (20,000
            )
            
            
            (20,000
            )$
            439,739
            
            
            $
            203,267








August
      31,Inventories:
            
            2008
            
            
            2007Parts
      and supplies
            
            $
            802,956
            
            
            $
            835,498Work-in-process
            
            
            608,391
            
            
            
            610,846Finished
      goods
            
            
            53,806
            
            
            
            103,723Reserve
      for obsolete inventory
            
            
            (40,000
            )
            
            
            (40,000
            )$
            1,425,153
            
            
            $
            1,510,067








August
      31,Accrued
      liabilities:
            
            2008
            
            
            2007Accrued
      vacation
            
            $
            301,413
            
            
            $
            260,229Accrued
      taxes payable
            
            
            14,994
            
            
            
            46,842Accrued
      bonuses
            
            
            161,000
            
            
            
            115,000Other
      accrued liabilities
            
            
            108,370
            
            
            
            211,019$
            585,777
            
            
            $
            633,090





Return to Table of Contents
 F-13




Note
3:  Investments





As of
August 31, 2008 and 2007, investments consisted primarily of a managed portfolio
of mutual funds, and were all considered available-for-sale
securities.  As of August 31, 2008, investments had a cost, determined
on a specific identification method, of $16,628,608, fair value of $14,487,192
and unrealized losses of $2,141,416.  As of August 31, 2007,
investments had a cost of $19,662,878, fair value of $19,090,118 and unrealized
losses of $572,760.  Realized losses on investments were $181,107 for
the year ended August 31, 2008, with total sales proceeds of
$4,688,760.  No realized gains or losses on investments were recorded
in the years ended August 31, 2007 and 2006.








Note
4:  Property and Equipment





Property and equipment consists of the
following:





August
      31,2008
            
            
            2007Equipment
            
            $
            1,048,061
            
            
            $
            962,162Furniture
      and fixtures
            
            
            298,576
            
            
            
            298,576Leasehold
      improvements
            
            
            17,420
            
            
            
            17,420Building
            
            
            956,000
            
            
            
            -Land
            
            
            244,000
            
            
            
            -2,564,057
            
            
            
            1,278,158Less
      accumulated depreciation
            
            
            (1,122,533
            )
            
            
            (1,007,081
            )$
            1,441,524
            
            
            $
            271,077





Depreciation expense for the years
ended August 31, 2008, 2007 and 2006 totaled $117,207, $95,971 and $84,982,
respectively.








Note
5:  Patents





The Company has four patents recorded
net of accumulated amortization.  The patents are being amortized on a
straight-line basis over their estimated useful life with an amortization period
of 17 years. Amortization expense was $3,009, $1,878 and $1,878 for the years
ended August 31, 2008, 2007, and 2006, respectively.  For each of the
next five years, amortization expense relating to the patents is expected to be
$3,111 per year.








Note
6:  Operating Lease





When the
lease on the Company’s office, production and research facilities expired in
November 2007, the Company exercised its option to purchase the building and
land for a total purchase price of $1,200,000.







Return to Table of Contents
 F-14




Note
7:  Deferred Revenue





The
Company has entered into certain service contracts for which it has received
payment in advance.  The Company is recognizing these service revenues
over the life of the service agreements.





As of
August 31, 2008 and 2007, the Company had $95,979 and $74,448 of deferred
revenue, respectively.








Note
8:  Major Customers and Foreign Sales





The
Company had the following customer revenue concentrations:





Years
      Ended August 31,2008
            2007
            2006Customer
      A
            54.62%
            48.88%
            23.77%Customer
      B
            *
            *
            45.48%Customer
      C
            *
            *
            10.38%





*Sales to
customers were less than 10%.




Export
sales were $2,812,796, $1,787,363 and $2,413,807 in fiscal years 2008, 2007 and
2006, respectively.




During
fiscal years 2008 and 2007, export sales to Switzerland were approximately 53%
and 44% of total sales, respectively.  During fiscal year 2006, export
sales to China, Switzerland and Poland were approximately 45%, 21% and 10% of
total sales, respectively.







Note
9:  Income Taxes





The components of the income tax
(provision) benefit are as follows:





Years
      Ended August 31,2008
            
            
            2007
            
            
            2006Current:Federal
            
            $
            1,088,000
            
            
            $
            1,653,000
            
            
            $
            (4,606,000
            )State
            
            
            41,000
            
            
            
            146,000
            
            
            
            (690,000
            )1,129,000
            
            
            
            1,799,000
            
            
            
            (5,296,000
            )Deferred:Federal
            
            
            (168,000
            )
            
            
            66,000
            
            
            
            87,000$
            961,000
            
            
            $
            1,865,000
            
            
            $
            (5,209,000
            )





Return to Table of Contents
 F-15


The
income tax (provision) benefit differs from the amount computed at federal
statutory rates as follows:




Years
      Ended August 31,2008
            
            
            2007
            
            
            2006Income
      tax (provision) benefit atfederal statutory rate
            
            $
            1,156,000
            
            
            $
            1,772,000
            
            
            $
            (5,393,000
            )Stock-based
      compensation
            
            
            (176,000
            )
            
            
            (233,000
            )
            
            
            -State
      income taxes, net of federal benefit
            
            
            288,000
            
            
            
            96,000
            
            
            
            -Research
      and development credit
            
            
            160,000
            
            
            
            160,000
            
            
            
            190,000Valuation
      allowance
            
            
            (518,000
            )
            
            
            -
            
            
            
            -Other
            
            
            51,000
            
            
            
            70,000
            
            
            
            (6,000
            )$
            961,000
            
            
            $
            1,865,000
            
            
            $
            (5,209,000
            )





Deferred
tax assets (liabilities) are comprised of the following:





August
      31,2008
            
            
            2007Current
      Asset:Accruals
      and reserves
            
            $
            145,000
            
            
            $
            129,000Deferred
      revenue
            
            
            36,000
            
            
            
            28,000Inventories
            
            
            15,000
            
            
            
            18,000State
      net operating loss carryforward
            
            
            252,000
            
            
            
            -Unrealized
      loss on investments
            
            
            792,000
            
            
            
            212,000Valuation
      allowance
            
            
            (1,240,000
            )
            
            
            -$
            -
            
            
            $
            387,000Long-Term
      Asset:Deferred
      compensation
            
            $
            120,000
            
            
            $
            112,000Depreciation
      and amortization
            
            
            (50,000
            )
            
            
            (43,000
            )Valuation
      allowance
            
            
            (70,000
            )
            
            
            -$
            -
            
            
            $
            69,000




The
Financial Accounting Standards Board (FASB) has issued Financial Interpretation
No. 48, Accounting for
Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109
(FIN 48).  FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting
for Income Taxes.  Fin 48 requires a company to determine
whether it is more likely than not that a tax position will be sustained upon
examination based upon the technical merits of the position.  If the
more-likely-than-not threshold is met, a company must measure the tax position
to determine the amount to recognize in the financial statements.  As
a result of the implementation of FIN 48, the Company performed a review of its
material tax positions in accordance with recognition and measurement standards
established by FIN 48.




At the
adoption date of September 1, 2007, the Company had no unrecognized tax benefit
which would affect the effective tax rate if recognized.  There has
been no significant change in the unrecognized tax benefit during the year ended
August 31, 2008.





The
Company classifies interest and penalties arising from the underpayment of
income taxes in the statements of operations in other income
(expense).  As of August 31, 2008, the Company had no accrued interest
or penalties related to uncertain tax positions.


Return to Table of Contents
 F-16





The
Company files income tax returns in the U.S. federal jurisdiction and various
state jurisdictions.  U.S. federal income tax returns from the year
ended August 31, 2006 through the year ended August 31, 2008 are subject to
examination.





The
ultimate realization of the deferred tax assets is dependent, in part, upon the
tax laws in effect, the Company’s future earnings, and other
events.  As of August 31, 2008, the Company recorded a valuation
allowance of $1,240,000 against current deferred tax assets and a valuation
allowance of $70,000 against net long-term deferred tax assets.  The
increase in the valuation allowance for the year ended August 31, 2008
relates primarily to our operating losses. The general valuation allowance has
been established under the provisions of SFAS No. 109, Accounting for Income Taxes,
which requires that a valuation allowance be established when it is more likely
than not that the net deferred tax assets will not be realized.





Note
10:  Stock-Based Compensation





The
Company’s Amended and Restated 1998 Stock Incentive Plan authorizes the granting
of incentive stock options to certain key employees and non-employees who
provide services to the Company.  The Plan, as amended, provides for
the granting of options for an aggregate of 3,427,300 shares.  The
options vest subject to management’s discretion.





The
Company’s Amended and Restated 1998 Directors Stock Plan provides an annual
retainer of $30,000 to each non-employee director with the exception of the
Audit Committee Chairman who is to receive $35,000.  The annual
compensation plan calls for payment to be made twice a year with each payment
consisting of $15,000 in cash and $15,000 in common stock, with the exception of
the Audit Committee Chairman who is to receive $20,000 in cash and $15,000 in
common stock with the number of shares issued calculated by dividing the unpaid
compensation by a daily average of the preceding twenty day closing price of the
Company’s common stock.  The Plan also grants each non-employee
outside director 30,000 options each year at an exercise price equal to the fair
market value of the common stock at the date the option is
granted.  The Plan allows for an aggregate of 1,500,000 shares to be
granted.  The options vest according to a set schedule over a
five-year period and expire upon the director’s termination, or after ten years
from the date of grant.





The
Company accounts for stock-based compensation in accordance with SFAS No.
123(R), Share Based Payments.  Under the fair value recognition
provisions of this statement, stock-based compensation cost is measured at the
grant date based on the value of the award granted using the Black-Scholes
option pricing model, and recognized over the period in which the award
vests.  The stock-based compensation expense for the year ended August
31, 2008 has been allocated to the various categories of operating costs and
expenses in a manner similar to the allocation of payroll expense as
follows:


Cost
      of sales
            
            $
            86,262Research
      and development
            
            
            136,993Selling,
      general and administrative
            
            
            577,177Total
            
            $
            800,432





Stock-based
compensation expense for the year ended August 31, 2007 of $832,224 has been
included in selling, general and administrative expenses.




Return to Table of Contents
 F-17


During
the year ended August 31, 2008, we granted 474,457 options to our directors and
employees, 302,457 options with one fifth vesting each year for the next five
years, and 172,000 options with one third vesting each year for the next three
years. These grants account for $532,550 of the total stock-based compensation
expense for the year ended August 31, 2008.




Unrecognized
stock-based compensation expense expected to be recognized over the estimated
weighted-average amortization period of 2.09 years is approximately $2,389,000
at August 31, 2008.




Our weighted-average assumptions used
in the Black-Scholes valuation model for equity awards with time-based vesting
provisions granted during the year ended August 31, 2008 are shown
below:




Expected
      volatility
            63.92%Expected
      dividends
            0%Expected
      term
            6.25
      YearsRisk-free
      interest rate
            3.85%





The
expected volatility rate was estimated based on the historical volatility of our
common stock.   The expected term was estimated based on
historical experience of stock option exercise and forfeiture.  The
risk-free interest rate is the rate provided by the U.S. Treasury for Daily
Treasury Yield Curve Rates commonly referred to as “Constant Maturity Treasury”
rate in effect at the time of grant with a remaining term equal to the expected
option term.




A summary
of the time-based stock option awards as of August 31, 2008, and changes during
the year then ended, is as follows:




Shares
            
            
            Weighted-
              Average
              Exercise
              Price
            
            
            Weighted-
              Average
              Remaining
              Contract
      Term
              (Years)
            
            Aggregate
              Intrinsic
              ValueOutstanding
      at August 31, 2007
            
            
            1,795,853
            
            
            $
            2.31Granted
            
            
            474,457
            
            
            
            5.54Exercised
            
            
            (87,681
            )
            
            
            2.17Forfeited
      or expired
            
            
            -
            
            
            
            -Outstanding
      at August 31, 2008
            
            
            2,182,629
            
            
            $
            3.02
            
            
            
            6.51Exercisable
      at August 31, 2008
            
            
            1,474,235
            
            
            $
            1.97
            
            
            
            5.42
            
            $     
      8,812,247





The
aggregate intrinsic value in the preceding table represents the total pretax
intrinsic value, based on the Company’s closing stock price of $7.95 as of
August 29, 2008, which would have been received by the holders of in-the-money
options had the option holders exercised their options as of that
date.





The
weighted-average grant-date fair value of stock options granted during the year
ended August 31, 2008 was $3.47.


Return to Table of Contents
 F-18


Note
11:  Related Party Transactions





During
the years ended August 31, 2008, 2007, and 2006, the Company had sales of
$2,809,132, $1,385,332 and $689,086, respectively, to an entity controlled by a
significant stockholder and member of the Board of Directors.  These
related party transactions represent 55%, 49% and 24% of total sales for each
respective year.





At August
31, 2008 and 2007, receivables include $737,483 and $488,200, respectively, from
this entity.





Note
12:  Supplemental Cash Flow Information





Actual
amounts paid for interest and income taxes are as follows:





Years
      Ended August 31,2008
            
            
            2007
            
            
            2006Interest
      expense
            
            $
            -
            
            
            $
            -
            
            
            $
            -Income
      taxes
            
            $
            8,929
            
            
            $
            1,798,676
            
            
            $
            2,576,605





The
Company had the following non-cash financing and investing
activities:





During
the year ended August 31, 2008, the Company:





·
            Recorded
      an increase in additional paid-in capital of $171,718 and an increase in
      income tax receivable of $171,718 related to the tax benefit from the
      exercise of stock options.·
            Increased
      other comprehensive loss by $1,780,656, decreased investments by
      $1,568,656 and decreased short-term deferred tax asset by
      $212,000.·
            Increased
      common stock and decreased additional paid-in capital by
    $24.During
      the year ended August 31, 2007, the Company:·
            Recorded
      an increase in additional paid in capital of $47,449 and corresponding
      decrease to income taxes payable related to the tax benefit from the
      exercise of stock options.·
            Increased
      other comprehensive loss by $261,398, decreased investments by $473,398
      and increased short-term deferred tax asset by
$212,000.·
            Transferred
      deferred compensation of $247,700 to additional paid-in
      capital.·
            Decreased
      income taxes payable and decreased income tax receivable by
      $39,946.·
            Increased
      common stock and decreased additional paid-in capital by
    $68.During
      the year ended August 31, 2006, the Company:·
            Had
      other comprehensive loss of $136,301.·
            Recorded
      deferred compensation of $301,700.·
            Recorded
      an increase in additional paid in capital of $972,282 and corresponding
      decrease to income taxes payable related to the tax benefit from the
      exercise of stock options.





Return to Table of Contents
 F-19


Note
13:  Commitments and Contingencies





We
entered into an employment agreement with the President of the Company dated
August 10, 1999. This agreement provides that the President shall receive an
annual base salary, which shall be reviewed annually by the Board of
Directors.   The President’s annual base salary was raised to
$250,000 effective September 1, 2006.  In the event of termination of
the President’s employment with the Company without cause (as defined in the
agreement) or the President’s resignation for good reason (as defined in the
agreement), the agreement provides that the President will receive severance
compensation for a period of six months, including an extension of all benefits
and perquisites. The severance amount shall include six months of salary at the
highest rate paid to the President prior to termination and an additional amount
equal to all bonuses received by the President during the 12-month period
preceding termination (excluding any signing bonus received during such
period).  The agreement also requires us to vest any options granted
to the President for the purchase of our Common Stock, allowing a 90-day period
for the President to exercise those options.  The President’s
agreement includes a non-competition covenant prohibiting him from competing
with us for one year following his termination.





We
entered into an employment agreement with the Chairman of the Board, Senior Vice
President and Chief Technical Officer dated November 2, 1988.  The
agreement sets the Chairman’s annual base salary for each year until October 1,
1993 and provides that after October 1, 1993 the Chairman’s annual base salary
will be based upon a reasonable mutual agreement between the Chairman and the
Company.  The Chairman’s annual base salary was raised to $210,000
effective September 1, 2006.  In the event of termination of the
Chairman’s employment with the Company without cause (as defined in the
agreement) or the Chairman’s resignation for good reason (as defined in the
agreement), the agreement provides that the Chairman will receive severance pay
for a one-year period, which pay includes an extension of all of his rights,
privileges and benefits as an employee (including medical
insurance).  The one-year severance pay shall be equal to the
Chairman’s average annual salary for the 12-month period immediately prior to
the termination.  The agreement also requires us to pay the Chairman
for any accrued, unused vacation at the time of termination.  We are
also obligated to pay the Chairman $1,000 (or the equivalent value in stock
options) for each newly issued patent obtained by us as a result of the
Chairman’s efforts (the Chairman receives only $500 if multiple inventors are
involved).  The Chairman’s agreement includes a non-competition
covenant prohibiting him from competing with us for one year following his
termination.  We may continue the non-competition period for up to
four additional years by notifying the Chairman in writing and by continuing the
severance payments for the additional years during which the non-competition
period is extended.





The
Company has an exclusive worldwide license for a unique temperature
probe.  The license has no determinable life.  The Company
pays royalties based upon its sales of this probe.  Accrued royalties
were $1,890 and $1,120 as of August 31, 2008 and 2007,
respectively.  Royalty expense amounted to $4,760, $5,445 and $6,180
for the years ended August 31, 2008, 2007 and 2006,
respectively.


Return to Table of Contents
 F-20




Note
14:  Fair Value of Financial Instruments





None of
the Company's financial instruments are held for trading
purposes.  The Company estimates that the fair value of all financial
instruments at August 31, 2008 and 2007 does not differ materially from the
aggregate carrying values of its financial instruments recorded in the
accompanying balance sheets.  The estimated fair value amounts have
been determined by the Company using available market information and
appropriate valuation methodologies.  Considerable judgment is
necessarily required in interpreting market data to develop the estimates of
fair value, and, accordingly, the estimates are not necessarily indicative of
the amounts that the Company could realize in a current market
exchange.








Note
15:  Sale of Equity Interest





The
Company held an equity interest in TherMatrx, Inc. (“TherMatrx”) until July 15,
2004.  On July 15, 2004, TherMatrx was sold to American Medical
Systems Holdings, Inc. (AMS).  The Company’s part of the total
proceeds from this sale was approximately 25%.  A portion of the
payout from the sale was based on contingency payments.  By the close
of fiscal year 2006, the Company had received a total payout, including
contingency payments, of approximately $33.5 million.





In April
2007, the Company received an additional $202,223 in proceeds from the sale of
TherMatrx.








Note
16:  Recent Accounting Pronouncements





On May 9,
2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No.
162, The Hierarchy of
Generally Accepted Accounting Principles.  This statement is
intended to improve financial reporting by identifying a consistent framework,
or hierarchy, for selecting accounting principles to be used in preparing
financial statements in conformity with U.S. generally accepted accounting
principles (GAAP) for nongovernmental entities.  The statement
establishes that the GAAP hierarchy should be directed to entities because it is
the entity (not its auditor) that is responsible for selecting accounting
principles for financial statements that are presented in conformity with
GAAP.  This statement is effective 60 days following the SEC’s
approval of the Public Company Accounting Oversight Board Auditing amendments to
AU Section 411, The Meaning of
Present Fairly in Conformity with Generally Accepted Accounting
Principles.  We do not believe the implementation of this
statement will have a material impact on our financial statements.





In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities.  This statement changes the
disclosure requirements for derivative instruments and hedging
activities.  Entities are required to provide enhanced disclosures
about (a) how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, and its related interpretations, and
(c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows.  This
statement is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, or our fiscal year beginning
September 1, 2009, with early application encouraged.  This statement
encourages, but does not require, comparative disclosures for earlier periods at
initial adoption.  We currently are unable to determine what impact
the future application of this pronouncement may have on our financial
statements.





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 F-21


In
December 2007, the FASB issued SFAS No. 141(R) (revised 2007), Business
Combinations.  This statement replaces SFAS No. 141, Business Combinations and
applies to all transactions or other events in which an entity (the acquirer)
obtains control of one or more businesses (the acquiree), including those
sometimes referred to as “true mergers” or “mergers of equals” and combinations
achieved without the transfer of consideration.  This statement
establishes principles and requirements for how the acquirer: a) recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any noncontrolling interest in the acquiree; b)
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase; and c) determines what information to disclose to
enable users of the financials statements to evaluate the nature and financial
effects of the business combination.  This statement will be effective
for fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2008, or our fiscal year beginning September 1,
2009.  Earlier adoption is prohibited.  We currently are
unable to determine what impact the future application of this pronouncement may
have on our financial statements.





In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements.  This statement applies to
all entities that prepare consolidated financial statements, except
not-for-profit organizations, and amends Accounting Research Bulletin (“ARB”) 51
to establish accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary.  It also
amends certain of ARB 51’s consolidation procedures for consistency with the
requirements of SFAS No. 141 (revised 2007).  This statement will be
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008, or our fiscal year beginning September
1, 2009.  Earlier adoption is prohibited.  We currently are
unable to determine what impact the future application of this pronouncement may
have on our financial statements.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities – Including an Amendment of FASB Statement No.
115. This statement permits entities to choose to measure many financial
instruments and certain other items at fair value.  Most of the
provisions of SFAS No. 159 apply only to entities that elect the fair value
option.  However, the amendment to SFAS No. 115 Accounting for Certain Investments
in Debt and Equity Securities applies to all entities with
available-for-sale and trading securities.  SFAS No. 159 is effective
as of the beginning of an entity’s first fiscal year that begins after November
15, 2007.  We adopted SFAS No. 159 on September 1, 2008, with no
material impact on our financial statements.





In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS
No. 157 defines fair value, establishes a framework for measuring fair value,
and requires enhanced disclosures about fair value measurements.  SFAS
No. 157 requires companies to disclose the fair value of their financial
instruments according to a fair value hierarchy as defined in the
standard.  Additionally, companies are required to provide enhanced
disclosure regarding financial instruments in one of the categories, including a
reconciliation of the beginning and ending balances separately for each major
category of assets and liabilities.  In February 2008, the FASB issued
FASB Staff Position (FSP) No. FAS 157-2, which delays by one year the effective
date of SFAS No. 157 for certain types of non-financial assets and non-financial
liabilities.  As a result, SFAS No. 157 will be effective for
financial statements issued for fiscal years beginning after November 15, 2007
for financial assets and liabilities carried at fair value on a recurring basis,
and for fiscal years beginning after November 15, 2008 for non-recurring
non-financial assets and liabilities that are recognized or disclosed at fair
value.  In October 2008, the FASB issued FSP No. 157-3,
Determining the Fair Value of
a Financial Asset When the Market for That Asset is Not Active, or FSP
157-3.  FSP 157-3 clarifies the application of SFAS 157 in a market that is
not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that
financial asset is not active.  FSP 157-3 was effective upon issuance,
including prior periods for which financial statements have not been
issued.


Return to Table of Contents
 F-22





We
adopted SFAS No. 157 for financial assets and liabilities carried at fair value
on a recurring basis on September 1, 2008, with no material impact on our
financial statements.  W are currently unable to determine the impact
on our financial statements of the application of SFAS No. 157 on September 1,
2009, for non-recurring non-financial assets and liabilities that are recognized
or disclosed at fair value.





EITF No.
07-3, Accounting for
Nonrefundable Advance Payments for Goods or Services Received for Use in Future
Research and Development Activities,was issued in June
2007.  The EITF reached a consensus that nonrefundable payments for
goods and services that will be used or rendered for future research and
development activities should be deferred and capitalized.  Such
amounts should be recognized as an expense as the related goods are delivered
and the related services are performed.  Entities should continue to
evaluate whether they expect the goods to be delivered or services to be
rendered.  If the entity does not expect the goods to be delivered or
services to be rendered, the capitalized advance payment should be charged to
expense.  This pronouncement is effective for financial statements
issued for fiscal years beginning after December 15, 2007.  We adopted
EITF No. 07-3 on September 1, 2008, with no material impact our financial
statements.




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Contents


F-23