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Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2010
or
     
o   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: 001-33452
TomoTherapy Incorporated
(Exact name of registrant as specified in its charter)
     
Wisconsin
(State or other jurisdiction of incorporation or organization)
  39-1914727
(I.R.S. Employer Identification No.)
     
1240 Deming Way, Madison, Wisconsin
(Address of principal executive offices)
  53717
(Zip Code)
(608) 824-2800
(Registrant’s telephone number, including area code)
NO CHANGE
(Former name, former address and former fiscal year, if changed since last report)
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Number of shares of Common Stock outstanding as of April 30, 2010: 54,104,162 shares.
 
 

 

 


 

TomoTherapy Incorporated and Subsidiaries
Index
         
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    17  
 
       
    26  
 
       
    26  
 
       
       
 
       
    27  
 
       
    27  
 
       
    29  
 
       
    29  
 
       
    29  
 
       
    29  
 
       
    30  
 
       
    31  
 
       
    32  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

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Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.  
Financial Statements
TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(unaudited)
                 
    March 31,     December 31,  
    2010     2009  
 
               
ASSETS
Cash and cash equivalents (CPAC balances of $6,300 and $1,590, respectively)
  $ 92,071     $ 76,108  
Short-term investments
    56,632       78,225  
Receivables, net
    33,660       33,559  
Inventories, net
    53,555       47,669  
Prepaid expenses and other current assets (CPAC balances of $939 and $494, respectively)
    4,326       3,633  
 
           
Total current assets
    240,244       239,194  
Property and equipment, net (CPAC balances of $1,152 and $555, respectively)
    18,383       18,628  
Other non-current assets, net (CPAC balances of $25 and $30, respectively)
    11,582       12,429  
 
           
TOTAL ASSETS
  $ 270,209     $ 270,251  
 
           
 
               
LIABILITIES AND EQUITY
Accounts payable (CPAC balances of $443 and $24, respectively)
  $ 11,812     $ 6,269  
Accrued expenses (CPAC balances of $62 and $20, respectively)
    17,384       19,588  
Accrued warranty
    3,579       4,173  
Deferred revenue
    32,780       34,145  
Customer deposits
    10,567       13,266  
 
           
Total current liabilities
    76,122       77,441  
Other non-current liabilities (CPAC balances of $19 and $18, respectively)
    3,995       5,475  
 
           
TOTAL LIABILITIES
    80,117       82,916  
 
           
 
               
COMMITMENTS AND CONTINGENCIES (Note G)
               
 
               
Preferred stock, $1 per share par value, 10,000,000 shares authorized at March 31, 2010 and December 31, 2009; no shares issued and outstanding at March 31, 2010 and December 31, 2009
           
Common stock, $0.01 per share par value, 200,000,000 shares authorized at March 31, 2010 and December 31, 2009; 54,144,133 and 54,102,360 shares issued and outstanding at March 31, 2010 and 53,980,728 and 53,938,955 shares issued and outstanding at December 31, 2009
    517       515  
Additional paid-in capital
    669,567       667,177  
Treasury stock, 41,773 shares at cost at March 31, 2010 and December 31, 2009
    (137 )     (137 )
Accumulated other comprehensive loss
    (575 )     (268 )
Accumulated deficit
    (488,541 )     (483,863 )
 
           
Total shareholders’ equity
    180,831       183,424  
Noncontrolling interests
    9,261       3,911  
 
           
TOTAL EQUITY
    190,092       187,335  
 
           
TOTAL LIABILITIES AND EQUITY
  $ 270,209     $ 270,251  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
                 
    Three Months Ended March 31,  
    2010     2009  
Revenue:
               
Product
  $ 29,229     $ 21,133  
Service and other
    12,851       9,490  
 
           
Total revenue
    42,080       30,623  
 
           
Cost of revenue:
               
Product
    12,785       11,745  
Service and other
    16,691       16,339  
 
           
Total cost of revenue
    29,476       28,084  
 
           
Gross profit
    12,604       2,539  
 
           
Operating expenses:
               
Research and development
    7,540       5,849  
Selling, general and administrative
    11,034       10,652  
 
           
Total operating expenses
    18,574       16,501  
 
           
Loss from operations
    (5,970 )     (13,962 )
Other income (expense):
               
Interest income
    531       697  
Interest expense
    (11 )     (14 )
Other expense, net
    (448 )     (256 )
 
           
Total other income
    72       427  
 
           
Loss before income tax
    (5,898 )     (13,535 )
Income tax benefit
    44       100  
 
           
Net loss
    (5,854 )     (13,435 )
Noncontrolling interests
    1,176       436  
 
           
Net loss attributable to shareholders
  $ (4,678 )   $ (12,999 )
 
           
 
               
Weighted-average common shares outstanding — basic and diluted
    51,566       50,592  
 
           
 
               
Loss per common share — basic and diluted
  $ (0.09 )   $ (0.26 )
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
                 
    Three Months Ended March 31,  
    2010     2009  
       
Cash flows from operating activities:
               
Net loss
  $ (5,854 )   $ (13,435 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    2,503       2,422  
Share-based compensation
    1,819       1,490  
Deferred income tax benefit
    (72 )     (172 )
Other noncash items
    2       16  
Changes in operating assets and liabilities:
               
Receivables, net
    (181 )     8,480  
Inventories, net
    (6,136 )     (783 )
Other assets
    (1,109 )     (666 )
Accounts payable
    5,548       3,278  
Accrued expenses
    (2,348 )     (2,063 )
Accrued warranty
    (594 )     (1,598 )
Deferred revenue
    (1,950 )     2,158  
Customer deposits
    (2,699 )     (752 )
 
           
Net cash used in operating activities
    (11,071 )     (1,625 )
 
           
Cash flows from investing activities:
               
Purchases of property and equipment
    (1,239 )     (1,170 )
Purchases of short-term investments
          (7,499 )
Proceeds from sales and maturities of short-term investments
    21,250       4,876  
Other investing activities
    (241 )     (922 )
 
           
Net cash provided by (used in) investing activities
    19,770       (4,715 )
 
           
Cash flows from financing activities:
               
Payments on notes payable
    (34 )     (35 )
Proceeds from exercises of stock options and warrants
    573       2  
Proceeds from issuance of CPAC common stock
    6,526       6,364  
 
           
Net cash provided by financing activities
    7,065       6,331  
Effect of exchange rate changes on cash and cash equivalents
    199       671  
 
           
Increase in cash and cash equivalents
    15,963       662  
Cash and cash equivalents at beginning of period
    76,108       65,967  
 
           
Cash and cash equivalents at end of period
  $ 92,071     $ 66,629  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(In thousands)
(unaudited)
                                                         
    Shareholders’ Equity              
                            Accumulated                    
            Additional             Other                    
    Common     Paid-in     Treasury     Comprehensive     Accumulated     Noncontrolling        
    Stock     Capital     Stock     Income (Loss)     Deficit     Interests     Total Equity  
                                            (As adjusted,          
                                            Note B)          
 
                                                       
Balance at December 31, 2008
  $ 506     $ 659,379     $     $ 202     $ (446,493 )   $ 2,155     $ 215,749  
Net loss
                            (12,999 )     (436 )     (13,435 )
Other comprehensive loss
                      (428 )                 (428 )
 
                                                     
Comprehensive loss
                                                    (13,863 )
 
                                                     
Issuance of common stock
                                  6,364       6,364  
Exercise of stock options and common stock warrants
          2                               2  
Share-based compensation expense
          1,490                               1,490  
 
                                         
Balance at March 31, 2009
  $ 506     $ 660,871     $     $ (226 )   $ (459,492 )   $ 8,083     $ 209,742  
 
                                         
 
                                                       
Balance at December 31, 2009
  $ 515     $ 667,177     $ (137 )   $ (268 )   $ (483,863 )   $ 3,911     $ 187,335  
Net loss
                            (4,678 )     (1,176 )     (5,854 )
Other comprehensive loss
                      (307 )                 (307 )
 
                                                     
Comprehensive loss
                                                    (6,161 )
 
                                                     
Issuance of common stock
                                  6,526       6,526  
Exercise of stock options
    2       571                               573  
Share-based compensation expense
          1,819                               1,819  
 
                                         
Balance at March 31, 2010
  $ 517     $ 669,567     $ (137 )   $ (575 )   $ (488,541 )   $ 9,261     $ 190,092  
 
                                         
The accompanying notes are an integral part of these condensed consolidated statements.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A — DESCRIPTION OF BUSINESS
Organization
The organization is comprised of TomoTherapy Incorporated, a Wisconsin corporation (Tomo), its wholly-owned subsidiaries and its minority-owned affiliate (collectively, together with Tomo, the Company). Tomo and its wholly-owned subsidiaries (TomoTherapy) develop, manufacture, market and sell advanced radiation therapy solutions to treat a wide range of cancer types. The treatment systems in the Company’s platform (collectively, the System or Systems) include: (1) the flagship Hi Art treatment system, which delivers CT-guided, helical intensity-modulated radiation therapy (IMRT) treatment fractions, (2) the TomoHD treatment system, which includes both the TomoHelical and TomoDirect treatment modalities, and (3) the TomoMobile treatment system, which is a relocatable radiation therapy solution. TomoTherapy markets and sells its products to hospitals and cancer treatment centers in North America, Europe, the Middle East and Asia-Pacific. Compact Particle Acceleration Corporation (CPAC), Tomo’s controlled, minority-owned affiliate, is an enterprise focused on the development of a proton therapy system.
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The Company’s condensed consolidated financial statements include the accounts of CPAC. Although Tomo’s ownership in CPAC is less than 50%, it has consolidated CPAC, as Tomo is the primary beneficiary of CPAC, due to its overall control of CPAC’s activities and Tomo’s ownership interest in CPAC. Therefore, CPAC’s outside stockholders’ interests are shown in the Company’s condensed consolidated financial statements as “Non-controlling interests.” Significant intercompany balances and transactions have been eliminated in consolidation.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and pursuant to the accounting and disclosure rules and regulations of the Securities and Exchange Commission (SEC). Certain information and disclosures normally included in the consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes thereto included in the Company’s Annual Report for the year ended December 31, 2009 as filed with the SEC on Form 10-K. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of results that may be expected for the year ending December 31, 2010.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at the date of the condensed consolidated financial statements and the reported amount of revenues and expenses and cash flows during the periods presented. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and long-term debt. The carrying value of these assets and liabilities approximate their respective fair values as of March 31, 2010 and December 31, 2009.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Revenue Recognition
In September 2009, the Financial Accounting Standards Board (FASB) amended the accounting guidance on revenue recognition. Under the amended guidance, consideration in a multiple element arrangement may now be allocated in a manner that more closely reflects the structure of the transaction (“new revenue guidance”). Also, under the new revenue guidance, tangible products that contain software components essential to the functionality of the tangible product will no longer be subject to software revenue recognition guidance and will now be subject to other revenue guidance.
The Company elected to early adopt this new revenue guidance at the beginning of its first quarter of fiscal 2010 on a prospective basis for applicable arrangements originating or materially modified on or after January 1, 2010. For the first quarter of 2010, adoption of the new revenue guidance did not have a material impact on its condensed consolidated financial statements and the Company does not expect the new revenue guidance will have a material impact on its consolidated financial statements in future periods.
The Company recognizes revenue from System sales, including sales to distributors, and related services, when earned. Revenue is recognized when the following criteria are met: persuasive evidence of an arrangement exists, title and risk of loss have been transferred to the customer, the sales price is fixed or determinable and collection is reasonably assured.
Payments received for products prior to shipment are recorded as customer deposits. Once a System has been shipped, the related deposits are transferred to deferred revenue until the criteria for revenue recognition are satisfied.
The Company recognizes revenue in connection with distributor sales of the System based on the distributor’s certification status. If a distributor is certified by the Company to provide installation, testing, training and post-installation warranty services to end customers, the Company recognizes revenue upon shipment to that certified distributor, at which time the Company’s only remaining obligation is its post-installation warranty services to the distributor. The Company recognizes revenue for direct sales and sales through distributors that are not certified upon receipt of the signed acceptance procedure document from the end customer. Distributors do not have any contractual right of return, and the Company has not accepted any System returns from any distributor.
The Company frequently enters into sales arrangements with customers that contain multiple elements or deliverables such as hardware and post-warranty maintenance services. For such arrangements, the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the new revenue guidance establishes a hierarchy to determine the selling price to be used for allocating revenue to deliverables as follows: (i) vendor-specific objective evidence of fair value (VSOE), (ii) third-party evidence of selling price (TPE), and (iii) best estimate of the selling price (ESP). Under previous guidance, in instances when evidence of VSOE of all undelivered elements exists, evidence does not exist for one or more delivered elements and the fair value of all of the undelivered elements is less than the arrangement fee, revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. The residual method of accounting for revenue from multiple element arrangements is no longer permitted for transactions subject to the new revenue guidance.
Payments received for post-warranty maintenance services on the System are recorded as deferred revenue upon receipt and are recognized as revenue ratably over the term of the contract, which generally ranges from twelve to sixty months.
The Company sells optional software packages for which the selling price, cost and functionality are incidental to the operation of the System itself. The Company recognizes revenue for these optional software packages when all of the following criteria are met: persuasive evidence of an arrangement exists, the fee is fixed or determinable, collection of the related receivable is reasonably assured and delivery of the product has occurred, provided that all other criteria for revenue recognition have been met. Revenue earned on software arrangements involving multiple elements is allocated to each element using the hierarchy in the new revenue guidance.
The Company records all revenue net of any governmental taxes.
Capitalized Software Development Costs
Software development costs incurred prior to the establishment of technological feasibility are expensed when incurred and are included in research and development expense. Technological feasibility is evaluated for each software version developed and can occur early or later in the development cycle depending on the nature of the development project. Once the software has reached technological feasibility, all subsequent software development costs are capitalized until that software is released for sale. After the software is released for sale, the capitalized software development cost is amortized over the software’s useful life, and the related expense is charged to cost of revenue. The Company reviews its capitalized software development costs for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Share-Based Compensation
Share-based compensation to employees, including grants of employee stock options and stock sold pursuant to employee stock purchase plans, is measured at fair value and expensed in the condensed consolidated statements of operations over the service period of the grant, which is generally the vesting period. The Company uses the Black-Scholes option-pricing model to value stock options. The Company uses historical stock prices of a peer group of companies as the basis for its volatility assumptions. The assumed risk-free rates are based on U.S. Treasury rates in effect at the time of grant with a term consistent with the expected option lives. The Company employs the plain-vanilla method of estimating the expected term of the options, as the Company does not have significant historical experience. The forfeiture rate is based on past history of forfeited options. The expected dividend yield is based on the Company’s history of not paying dividends. The Company continues to account for options issued prior to January 1, 2006 under an intrinsic value method.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance if, based upon management’s estimates, it is more likely than not that a portion or all of the net deferred tax assets will not be realized. The factors used to assess the likelihood of realization are primarily the forecast of future taxable income and the remaining time period to utilize any tax operating losses and tax credits.
The Company’s practice for accounting for uncertainty in income taxes is to recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not criteria, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. The unrecognized tax benefits relate primarily to federal and state research tax credits.
Recent Accounting Pronouncements
In September 2006, the FASB issued new accounting guidance on fair value measurements and disclosures. The new guidance defines fair value, establishes a framework for measuring fair value under U.S. GAAP and enhances disclosures about fair value measurements. In February 2008, the FASB issued further guidance, which provided a one year deferral of the effective date for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. This guidance applies under other accounting pronouncements that require or permit fair value measurements, as the FASB previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this guidance does not require any new fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The adoption of the new guidance in 2008 and the further guidance in 2009 did not have a material impact on the Company’s condensed consolidated financial statements.
In June 2009, the FASB issued revised guidance for the accounting of variable interest entities. This revised guidance replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and has the obligation to absorb losses or the right to receive benefits from the entity that could be potentially significant to the variable interest entity. The accounting guidance also requires an ongoing reassessment of whether an enterprise is the primary beneficiary and requires additional disclosures about an enterprise’s involvement in variable interest entities. The adoption of this accounting guidance, which became effective for the Company beginning in the first quarter of fiscal 2010, did not have a material impact on the Company’s condensed consolidated financial statements.
NOTE C — SUPPLEMENTAL FINANCIAL INFORMATION
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The carrying value of these investments approximates their fair value.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Short-term Investments
Investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term if they are highly liquid, as such securities represent the investment of cash that is available for current operations. All short-term investments are classified as available for sale and are recorded at fair value using the specific identification method. Unrealized changes in fair value, net of tax, are reflected in the condensed consolidated financial statements as “Other comprehensive income (loss).”
Investments consisted of the following (in thousands):
                                 
    March 31, 2010  
    Cost basis     Unrealized gains     Unrealized losses     Fair value  
U.S. Government and Agency securities
  $ 43,456     $ 813     $     $ 44,269  
Corporate bonds
    12,099       264             12,363  
 
                       
 
  $ 55,555     $ 1,077     $     $ 56,632  
 
                       
                                 
    December 31, 2009  
    Cost basis     Unrealized gains     Unrealized losses     Fair value  
U.S. Government and Agency securities
  $ 60,531     $ 1,043     $     $ 61,574  
Corporate bonds
    16,334       317             16,651  
 
                       
 
  $ 76,865     $ 1,360     $     $ 78,225  
 
                       
The remaining maturities of debt securities were as follows (in thousands):
                                 
    March 31, 2010     December 31, 2009  
    Cost basis     Fair value     Cost basis     Fair value  
Due in one year or less
  $ 30,817     $ 31,124     $ 48,345     $ 48,809  
Due after one year through five years
    24,738       25,508       28,520       29,416  
 
                       
 
  $ 55,555     $ 56,632     $ 76,865     $ 78,225  
 
                       
The Company determines the fair value of its investments using a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:
   
Level 1 — Quoted prices in active markets for identical assets or liabilities.
   
Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
   
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
As of March 31, 2010, the Company’s financial assets, which consist of its investments, were measured at fair value employing Level 2 inputs.
Receivables, net
The Company’s receivables are mainly due from hospitals and cancer treatment centers. Credit is extended based on the Company’s evaluation of a customer’s financial condition, and collateral is not generally required. Accounts receivable are due in accordance with contract terms and are considered past due if not paid within 30 days of contract terms. In addition, the Company frequently enters into sales contracts for the System that require advance payments from customers.
The Company’s allowance for doubtful accounts reflects its best estimate of probable losses inherent in its accounts receivable balance. The Company determines the allowance based on known troubled accounts, historical experience and other available evidence. The Company’s allowance for doubtful accounts at March 31, 2010 and December 31, 2009 was $0.8 million and $0.7 million, respectively.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Inventories, net
Components of inventory include raw materials, work-in-process and finished goods. Finished goods include in-transit Systems that have been shipped to the Company’s customers or non-certified distributors, but are not yet installed and accepted by the end customer. All inventories are stated at the lower of cost or market, with cost determined by the first-in, first-out method. The Company reduces the carrying value of its inventories for differences between the cost and estimated net realizable value, taking into consideration usage in the preceding twelve months, expected demand, technological obsolescence and other information. The Company records as a charge to cost of revenue the amount required to reduce the carrying value of inventory to net realizable value. As of March 31, 2010 and December 31, 2009, the Company had an inventory reserve of $5.0 million and $5.1 million, respectively, which is primarily related to service spare parts inventory. In addition, costs associated with the procurement and warehousing of inventories, such as inbound freight charges and purchasing and receiving costs, are included in the cost of revenue line item within the statements of operations.
Net inventories consisted of the following (in thousands):
                 
    March 31,     December 31,  
    2010     2009  
Raw materials
  $ 41,490     $ 40,091  
Work-in-process
    4,843       1,847  
Finished goods
    7,222       5,731  
 
           
 
  $ 53,555     $ 47,669  
 
           
Accrued Expenses
Accrued expenses consisted of the following (in thousands):
                 
    March 31,     December 31,  
    2010     2009  
Commissions, severance and payroll-related
  $ 3,184     $ 4,531  
Bonuses
    1,077       1,705  
Accrued distributor relation costs
    5,318       5,188  
Sales, use and other indirect taxes
    2,838       3,450  
Other
    4,967       4,714  
 
           
 
  $ 17,384     $ 19,588  
 
           
Accrued Warranty
The Company’s sales terms include a warranty that generally covers the first year of System operation and is based on terms that are generally accepted in the marketplace. The Company records a current liability for the expected cost of warranty-related claims at the time of sale.
The following table presents changes in the Company’s product warranty accrual for the three months ended March 31, 2010 and 2009 (in thousands):
                 
    March 31,     March 31,  
    2010     2009  
Balance, beginning of period
  $ 4,173     $ 7,431  
Charged to cost of revenue
    1,260       1,341  
Adjustments related to change in estimate
    (373 )     (780 )
Actual product warranty expenditures
    (1,481 )     (2,159 )
 
           
Balance, end of period
  $ 3,579     $ 5,833  
 
           

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Deferred Revenue
Deferred revenue is recorded on a gross basis with the corresponding costs of revenue residing in inventory until such revenue is recognized. Deferred revenue includes amounts primarily related to services and, to a lesser extent, amounts related to product sales, including in-transit Systems that have shipped to the Company’s direct customers or non-certified distributors, but are not yet installed and accepted by the end customer. The Company ultimately expects to recognize these amounts as revenue upon performance of the services or once the Company’s product has been delivered and accepted by the customer.
The costs of revenue associated with services primarily relate to spare parts inventory along with the direct labor charges corresponding to post-warranty maintenance, which are recognized as incurred over the term of the service contract. The costs of revenue associated with product sales are comprised primarily of finished goods inventory, along with the corresponding installation costs, which are recognized as incurred once the product has been accepted by the customer.
Deferred revenue with expected recognition dates of greater than one year is classified in the consolidated financial statements as “Other non-current liabilities.” As of March 31, 2010 and December 31, 2009, the Company’s non-current deferred revenue was $2.1 million and $2.7 million, respectively.
Other Comprehensive Income (Loss)
Other comprehensive income (loss) refers to revenue, expenses, gains and losses that, under U.S. GAAP, are included in other comprehensive income (loss), but are excluded from net income (loss), as these amounts are recorded directly as an adjustment to shareholders’ equity, net of tax, when applicable. The Company had other comprehensive loss of $0.3 million and $0.4 million for the three months ended March 31, 2010 and 2009, respectively.
NOTE D — LOSS PER COMMON SHARE
The Company calculates its loss per common share using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. Under that method, income from continuing operations (or net income) is reduced by the amount of dividends declared in the current period for each class of stock and by the contractual amount of dividends (or interest on participating income bonds) that must be paid for the current period. The remaining earnings are allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. The total earnings allocated to each security are determined by adding together the amount allocated for dividends and the amount allocated for a participation feature. The total earnings allocated to each security are divided by the number of outstanding shares of the security to which the earnings are allocated to determine the earnings per share for the security.
For the three months ended March 31, 2010 and 2009, diluted net loss per share was the same as basic net loss per share since the effects of potentially dilutive securities are anti-dilutive.
Historical outstanding anti-dilutive securities not included in net loss per share calculation are as follows (in thousands):
                 
    Three Months Ended March 31,  
    2010     2009  
Stock options
    5,028       5,677  
Restricted stock
    2,436       1,446  
 
           
 
    7,464       7,123  
 
           
NOTE E — SEGMENT INFORMATION
The Company has determined that it operates in only one segment, as it only reports profit and loss information on an aggregate basis to its chief operating decision maker.
The Company categorizes revenue by major type. Refer to the condensed consolidated statement of operations for detail of revenue by major type.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
The Company also categorizes revenue by geographic region. Revenues are attributed to geographic region based on country location of the customer site. The following table summarizes revenue by geographic region (in thousands):
                 
    Three Months Ended March 31,  
    2010     2009  
Americas (1)
  $ 13,333     $ 18,239  
Europe and Middle East
    19,563       6,275  
Asia-Pacific
    9,184       6,109  
 
           
 
  $ 42,080     $ 30,623  
 
           
 
               
     
(1)  
Americas contains revenue from the United States of $12.7 million and $17.6 million for the periods ended March 31, 2010 and 2009, respectively.
NOTE F — INCOME TAXES
The estimated annual effective tax rate is adjusted quarterly, and items discrete to a specific quarter are reflected in tax expense for that interim period. The estimated annual effective income tax rate includes the effect of a valuation allowance expected to be necessary at the end of the year for deferred tax assets related to originating deductible temporary differences and carryforwards during the year. A valuation allowance is established when necessary to reduce deferred tax assets to an amount more-likely-than-not to be realized.
For the three months ended March 31, 2010 and 2009, the Company recorded an income tax benefit resulting in an effective income tax rate of 0.7%. The effective tax rate for the period differed significantly from the statutory tax rate primarily due to recording a valuation allowance for deferred tax assets in domestic and certain foreign taxing jurisdictions that are not more-likely-than-not to be realized. There were no material changes in unrecognized tax benefits during the three months ended March 31, 2010, nor does the Company anticipate a material change in total unrecognized tax benefits within the next 12 months.
NOTE G — COMMITMENTS AND CONTINGENCIES
On occasion, the Company is subject to proceedings, lawsuits and other claims related to patents, products and other matters. The Company assesses the likelihood of any adverse judgments or outcomes with respect to these matters and determines loss contingency assessments on a gross basis after assessing the probability of incurrence of a loss and whether a loss is reasonably estimable. In addition, the Company considers other relevant factors that could impact its ability to reasonably estimate a loss. A determination of the amount of reserves required, if any, for these contingencies is made after analyzing each matter. The Company’s reserves may change in the future due to new developments or changes in strategy in handling these matters.
Pending Litigation
On May 30, 2008 and June 10, 2008, two separate complaints were filed by certain shareholders of the Company in the U.S. District Court for the Western District of Wisconsin (the Court) against the Company and certain of its officers and all of its independent directors during the period in question. The complaints were consolidated on October 23, 2008. The consolidated action alleges that the defendants violated the Securities Act of 1933 (Securities Act) with respect to statements made in connection with the initial and secondary public offerings of the Company’s common stock and the Securities Exchange Act of 1934 (Exchange Act) by misrepresenting the Company’s projected financial outlook during the period May 9, 2007 through April 17, 2008. The named plaintiffs, Michael Schultz, John Scala, et al., seek to represent persons who purchased the Company’s securities between those dates and who were damaged as a result of the decline in the price of the Company’s stock between those dates, allegedly attributable to the financial misrepresentations, and seek compensatory damages in an unspecified amount.
The Company moved to dismiss the consolidated complaint on December 8, 2008. On July 9, 2009, the Court ruled on the motion to dismiss the consolidated complaint by dismissing without prejudice all claims under the Exchange Act and all but one claim under the Securities Act for failure to state a claim upon which relief could be granted. On August 3, 2009, the plaintiffs amended the consolidated complaint by filing their Second Amended Consolidated Complaint (the Amended Complaint). The Company moved to dismiss the Amended Complaint on September 3, 2009, and on December 15, 2009 the Court granted this second motion to dismiss in part and denied it in part. The plaintiffs have moved for class certification and briefing on that motion is ongoing. The Company continues to believe that it has substantial legal and factual defenses to the allegations contained in the Amended Complaint, and it intends to pursue these defenses vigorously. There can be no assurance, however, that the Company will prevail. Although the Company carries insurance for these types of claims and related defense costs, a judgment significantly in excess of the Company’s insurance coverage could materially and adversely affect the Company’s financial condition, results of operations and cash flows. As of March 31, 2010, the Company estimated that its potential loss from these claims and related defense costs will not exceed its insurance deductible of $0.5 million.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Reserve for Contingency
On July 17, 2009, Hi-Art Co., Ltd. (Hi-Art), the Company’s former distributor in Japan, filed a complaint against the Company in the Tokyo District Court seeking compensation it claims is owed by the Company. Although the Company believes it has substantial legal and factual defenses to Hi-Art’s allegations and intends to pursue these defenses vigorously, there can be no assurance that the Company will prevail. Accordingly, the Company maintains a reserve with respect to this matter.
Operating leases
The Company leases six facilities under separate operating leases with various expiration dates through 2018. The Company also leases automobiles under separate operating leases with various expiration dates through 2013. Rent expense was $1.2 million during the three months ended March 31, 2010 and 2009.
Initial terms for facility leases are up to 13 years, with renewal options at various intervals, and may include rent escalation clauses. The total amount of the minimum rent is expensed on a straight-line basis over the initial term of the lease unless external economic factors exist such that renewals are reasonably assured, in which case the Company includes the renewal period in its amortization period. Most of the leases provide that the Company pay taxes, maintenance, insurance and certain other expenses applicable to the leased premises. The Company expects that in the normal course of business leases that expire will be renewed or replaced by other leases.
NOTE H — STOCK INCENTIVE PLANS
The Company sponsors three stock plans, two stock incentive plans and an employee stock purchase plan (the Plans), which allow for the grant of incentive stock options, nonqualified stock options and restricted stock. Each option grant entitles the holder to purchase a specified number of shares of Tomo common stock at a specified price that may not be less than the fair market value on the grant date. Although the option grants under the Plans may have a maximum life of up to ten years, the majority of the grants made to date have lives of six years and vest at various intervals. Each restricted stock grant entitles the holder to receive a specified number of Tomo shares of common stock and vests at various intervals. Vesting schedules are determined at the grant date by the Compensation Committee of Tomo’s Board of Directors.
Tomo’s Board of Directors approved the 2007 Equity Incentive Plan and approved an amendment thereto in March 2009 (as amended, the 2007 Plan). Under the 2007 Plan, Tomo’s Board of Directors is authorized to grant stock-based awards to employees, directors, and consultants for up to 7,335,822 shares in aggregate. As of March 31, 2010, the two other plans remained in effect along with the 2007 Plan; however, equity-based awards may only be granted under the 2007 Plan.
The following table summarizes the activity under the Plans (in thousands, except for weighted-average exercise price and weighted-average fair value at grant date):
                                         
            Incentive Stock Options     Restricted Stock  
                          Weighted-  
    Shares     Number of     Weighted-             Average  
    Available     Options     Average     Number of     Fair Value  
    for Grant     Outstanding     Exercise Price     Shares     at Grant Date  
Balance at December 31, 2009
    3,667       5,347     $ 5.02       2,488     $ 5.01  
Exercised
          (213 )     2.69       (2 )     2.70  
Cancelled
    62       (106 )     7.32       (50 )     4.81  
 
                                 
Balance at March 31, 2010
    3,729       5,028     $ 5.07       2,436     $ 5.02  
 
                                 
Exercisable at March 31, 2010
            4,256     $ 4.61                  
 
                                     
At March 31, 2010, the Company’s weighted-average remaining contractual term was 3.3 years for all outstanding stock options, 3.3 years for outstanding vested stock options and 2.0 years for restricted stock. In addition, the Company’s aggregate intrinsic value was $1.4 million for all outstanding stock options and $1.3 million for outstanding vested stock options that were outstanding at March 31, 2010.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
The fair values of each option grant for the three months ended March 31, 2009 were estimated at the date of grant using the Black-Scholes option-pricing model based on the assumptions in the following table. There were no option grants during the three months ended March 31, 2010.
                 
    Three Months Ended March 31,  
    2010     2009  
Expected term (years)
    N/A       4.25  
Risk-free interest rate
    N/A       1.9 %
Expected volatility
    N/A       53 %
Expected dividend
    N/A       0 %
Expected forfeiture rate
    N/A       5.5 %
Weighted-average fair value at grant date
    N/A     $ 2.70  
NOTE I — RELATED PARTY TRANSACTIONS
The Company has an exclusive license agreement with the Wisconsin Alumni Research Foundation (WARF), a shareholder of the Company, to make, use, sell and otherwise distribute products under certain of WARF’s patents anywhere in the world. The Company is required to pay WARF a royalty for each product sold. The Company has recorded as cost of revenue WARF royalties of $0.2 million and $0.1 million during the three months ended March 31, 2010 and 2009, respectively. The license agreement expires upon expiration of the patents and may be terminated earlier if the Company so elects. The Company may also grant sublicenses to third parties but must pay WARF 50% of all fees, royalties and other payments received. WARF has the right to terminate the license agreement if the Company does not meet the minimum royalty obligations, which are $0.3 million per year, or if the Company commits any breach of the license agreement’s covenants. If the Company were to lose this license, it would be unable to produce or sell the System. The Company had WARF royalty payable balances of $0.2 million and $0.3 million as of March 31, 2010 and December 31, 2009, respectively.
NOTE J — INVESTMENT IN COMPACT PARTICLE ACCELERATION CORPORATION
During April 2008, Tomo established a new affiliate, CPAC, to develop a compact proton therapy system for the treatment of cancer. CPAC’s investors include Tomo, private investors and potential customers.
Although Tomo’s ownership in CPAC is less than 50%, it has consolidated CPAC, as Tomo is the primary beneficiary of CPAC, due to its overall control of CPAC’s activities and Tomo’s ownership interest in CPAC. Therefore, CPAC’s outside stockholders’ interests are shown in the Company’s condensed consolidated financial statements as “Non-controlling interests” (See Note B). Tomo contributed intellectual property with a fair market value of approximately $1.9 million as its investment in CPAC. CPAC raised additional capital from third-party investors of $6.9 million and $6.5 million in 2009 and during the three months ended March 31, 2010, respectively. As of December 31, 2009 and March 31, 2010, Tomo’s ownership interest in CPAC was 7.3% and 5.3%, respectively.
Other than a previously agreed to arms-length contractual agreement to provide certain support and management services, Tomo has not provided financial or other support to CPAC, and Tomo has no contractual obligation to provide financial support in the future beyond the aforementioned services. The assets of CPAC are restricted to the settlement of CPAC’s obligations. The creditors and beneficial interest holders of CPAC have no recourse to the general credit of Tomo.

 

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TOMOTHERAPY INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
NOTE K — RESTRUCTURING
In October 2009, Tomo’s management approved a restructuring program to downsize certain customer service and administrative functions and to terminate the employment of 61 employees during the period from October 14 through December 31, 2009. As a result of the restructuring program, the Company recognized a total restructuring charge of approximately $1.9 million in the fourth quarter of 2009. The remaining $0.1 million liability at March 31, 2010 is expected to be paid in 2010. A summary of activity for this liability is as follows (in thousands):
         
Balance, at December 31, 2009
  $ 998  
Additions
     
Payments
    (902 )
 
     
Balance, at March 31, 2010
  $ 96  
 
     

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read together with our unaudited condensed consolidated financial statements and the notes to those financial statements, which are included in this report. This report may contain or incorporate by reference forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These statements reflect management’s expectations, estimates and assumptions, based on information available at the time of the statement or, with respect to any document incorporated by reference, available at the time that such document was prepared. Forward-looking statements include, but are not limited to, statements regarding future events, plans, goals, objectives, prospects and expectations. Forward-looking statements are often, but not always, made through the use of words such as “believe,” “anticipate,” “should,” “intend,” “plan,” “will,” “likely,” “expect,” “estimate,” “project” and similar expressions. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and other factors, including, but not limited to, those discussed below under “Factors Affecting Our Financial Performance” and those in the section entitled “Risk Factors” under Part II, Item 1A. of this Quarterly Report on Form 10-Q, which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by those statements. We undertake no obligation to, and expressly disclaim any such obligation to, update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events or changes to future results over time or otherwise, except as required by law.
Overview
We develop, manufacture, market and sell advanced radiation therapy solutions to treat a wide range of cancer types. We market and sell our products to hospitals and cancer treatment centers in North America, Europe, the Middle East and Asia-Pacific and offer customer support services in each region either directly or through distributors.
The treatment systems in our TomoTherapy platform (collectively, the System or Systems) operate on a ring gantry and combine integrated CT imaging with conformal radiation therapy to deliver sophisticated radiation treatments with speed and precision while reducing radiation exposure to surrounding healthy tissue. Our Systems include: (1) the Hi Art treatment system, (2) the TomoHD treatment system, and (3) the TomoMobile relocatable radiation therapy solution. The Hi Art treatment system is our flagship product and has been used since 2003 to deliver CT-guided, helical intensity-modulated radiation therapy (IMRT) treatment fractions. The TomoHD treatment system was announced in October 2009, is targeted for shipment in the second half of 2010 and includes both our TomoHelical and TomoDirect treatment modalities to enable cancer centers to treat a broader patient population with a single device. The TomoMobile relocatable radiation therapy solution was first shipped in late 2009, consists of a standard TomoTherapy treatment system housed in a movable coach and is designed to improve access and availability of state-of-the-art cancer care.
For the three months ended March 31, 2010 and 2009, our revenue was $42.1 million and $30.6 million, respectively, an increase of 37%, and our net loss attributable to shareholders was $4.7 million and $13.0 million, respectively, a reduction of 64%. Our results of operations for the three months ended March 31, 2010 improved over the comparable 2009 period despite the continued impact of the global economic downturn, the ongoing credit crisis, uncertainty regarding national healthcare reform and enhanced competitive pressure. Although we experienced a net loss in the first quarter of 2010, we maintained a working capital balance of $164.1 million, including $148.7 million of cash and short-term investments as of March 31, 2010. Thus, we believe we will be able to fund ongoing operations and to invest in future product offerings for at least the next 12 months.
Despite continued economic uncertainty in 2010, we are encouraged by the improving trends in macroeconomic conditions and we remain confident in the future commercial demand for our technology and product offerings due to planned future new products and product enhancements and anticipated growth in demand for image-guided radiation therapy equipment.
Factors Affecting Our Financial Performance
Our financial performance is significantly affected by the following factors:
Incoming Orders
Since we sell high-priced capital equipment with a transaction cycle that can take many months between customer order and delivery, an important measure of our future financial performance is the dollar value of incoming orders for equipment. During the first three months of 2010, we experienced an increase in incoming orders as compared to the first three months of 2009 despite the continued impact of the global economic downturn, the ongoing credit crisis, increased competitive pressure and uncertainty regarding national healthcare reform. We believe this increase in orders is the result of improvements generated by the transition in sales leadership implemented during 2009, recent product introductions and improving trends in macroeconomic conditions.

 

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Since the System is a major capital expenditure, our customers may require funding through a credit facility or lease arrangement. In the current economic environment, some customers may have difficulty obtaining the necessary credit or are subject to increased constraints on their use of available cash. In addition, the current economic environment may cause potential new customers to delay placing capital equipment orders or to purchase equipment that is less costly.
We are still experiencing heightened competition in the marketplace; see Item 1A. Risk Factors in Part II to this Quarterly Report on Form 10-Q for further information. To counter this competitive pressure, we continue to strive to improve the quality and effectiveness of our sales force, increase our focus on group purchasing organizations and national accounts, increase our emphasis on regional user meetings and expand our product features. We have also extended our product portfolio from one to three market offerings. Furthermore, we believe continued innovation and expansion of our clinical capabilities will extend our technology leadership position, increase our prospects for greater market share and generate revenue growth.
Backlog
As of March 31, 2010, we had a backlog of $134.2 million, the majority of which we believe should convert to revenue within the next 12 months. We define backlog as the total contractual value of all firm orders received for the System and related options that we believe are likely to ship within 24 months. To be included in backlog, such orders must be evidenced by a signed quotation or purchase order from the customer or distributor.
On a regular basis, we review our open orders to determine if they meet our backlog definition by evaluating various factors including site identification, requested delivery date and customer or distributor history. If they no longer meet our backlog definition, due to uncertainty regarding customer project sites and customer shipping schedules, we remove the orders from our backlog. As a result of this process, one order was removed from our backlog during the three months ended March 31, 2010 due to a cancellation resulting from a change to the customer’s business plans.
Revenue
Product revenue. The majority of our product revenue is generated from sales of the System. We negotiate the actual purchase price with each customer or distributor, and, historically, the purchase price has varied across geographic regions.
While we are starting to see some improvement in the market, we expect our 2010 revenue to be comparable to 2009 revenue due to the combination of the continued impact of the global economic downturn, the ongoing credit crisis, uncertainty regarding national healthcare reform and enhanced competitive pressure. However, we remain confident in the future commercial demand for our technology and product offerings due to our planned future new products and product enhancements and anticipated growth in demand for image-guided radiation therapy equipment.
Our revenue projections can be impacted by a number of factors, including the following:
   
On average, the System is shipped to our customer within 12 months after we receive the order. However, individual orders may become delayed and take longer than 12 months to ship. Timing of deliveries can be affected by factors out of our control such as construction delays at customer project sites and customer credit issues. For direct and non-certified distributor sales, we recognize revenue upon end customer acceptance of the System, which usually occurs three to four weeks after its delivery. For certified distributor sales, we recognize revenue upon shipment of the System to the certified distributor. Each System installation represents a significant percentage of our revenue for the period in which it occurs.
   
Our geographic mix of customers may impact our average selling prices. Increased sales of the System outside of North America have tended to favorably impact our gross margins due to higher average selling prices in these markets. We intend to continue to expand our international selling efforts, although we cannot be certain that favorable pricing trends will continue. As of March 31, 2010, we did not have a hedging program in place to offset foreign exchange risk and, therefore, cannot be certain of how foreign currency exchange rates will impact our financial results in the future.
   
Our ability to demonstrate the clinical benefits of the System compared to competing systems is a factor in our ability to increase market demand for the System. To compete effectively, we may need to offer additional features that could require substantial additional resources to develop.
   
Our focus on sales to group purchasing organizations (GPOs) and multi-center customers may require us to lower selling prices, as these customers have negotiated quantity discounts. Orders from these customers may remain in backlog longer than those from customers who place single unit orders, as units sold to multi-center customers tend to install sequentially over a longer period of time.
   
The System is a major capital equipment item that represents a significant purchase for most of our customers. While we believe macroeconomic conditions are beginning to improve, our customers remain cautious and, as a result, may choose to delay some of their capital spending or may not have or be able to obtain the funds necessary to purchase equipment such as the System. As a result, our incoming orders and subsequent revenue recognition may be materially adversely affected.

 

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Also included in our product revenue are sales of optional equipment and software enhancements purchased by our end customers. Because we plan to further develop the System by adding upgraded features, we expect continued revenue growth from sales of optional equipment and software enhancements to new and existing customers.
Service revenue. Our service revenue is generated primarily from post-warranty service contracts and the sale of service spare parts. Our service contracts may be purchased with one-year or multiple-year terms and for a variety of service levels, giving our customers the option to contract for the level of support they desire. As of March 31, 2010, our most popular service plan continued to be our Total TLC Service Package (Total TLC). Under Total TLC, we provide customers with full spare parts coverage, including installation service by our field service engineers, full scheduled maintenance and unplanned repair service. We recognize service contract revenue ratably over the term of the contract. We recognize revenue from spare parts, which are primarily sold to our distributors, upon shipment. As the number of installed Systems continues to grow, we expect growth in our revenue from post-warranty service contracts.
Our ability to execute our strategies to increase incoming orders, to expand backlog with high quality orders, to raise sales of optional equipment and software enhancements and to grow our service revenue will have a direct impact on our ability to increase overall revenue in the future. If we are unable to successfully execute these strategies, we may generate revenue at levels that are lower than those we have generated in the past.
Cost of revenue
Cost of revenue includes all of our manufacturing and service costs. It consists of material, labor and overhead costs incurred in manufacturing the System. It also includes the cost of shipping the System to the customer site, installation costs, warranty provision and royalty payments to Wisconsin Alumni Research Foundation (WARF), one of our shareholders. Finally, cost of revenue includes the customer support expenses required to service and repair the System during the warranty and service contract periods.
In future periods, we expect to improve our gross margins through the following initiatives:
   
Service and support expenses. We have a small number of individual service contracts that produce negative gross profit margins for which we have recorded a reserve for the related estimated future losses. We anticipate the number of contracts producing negative margins will decline as we further our efforts in reducing the overall average direct service costs per installed System. We expect to continue to improve service contract margins by leveraging our service infrastructure costs over a larger installed base, increasing the price for some of our older annual service contracts, training our personnel to improve their problem-solving capabilities, implementing remote diagnostic functionalities, outsourcing certain tasks when cost-effective and feasible and introducing component design changes aimed at reducing costs, increasing longevity and improving serviceability of our spare parts. We believe that achieving certain of these initiatives should also lead to reduced warranty costs and improved System performance.
   
Component supply and cost. Our cost of revenue continues to be impacted by high component costs and high replacement rates. We continue to develop alternate components and implement enhancements to increase the performance of components used in the System. We are also seeking to identify lower-priced components of comparable or improved performance and quality, as well as making engineering improvements to the System in order to reduce costs. We believe that achieving these goals should result in reduced manufacturing, warranty and service support costs in the long term.
Our ability to execute on these strategies to reduce customer service and support expenses, as well as component costs and failure rates, will have a direct impact on our ability to improve profitability in the future. If we are unable to successfully execute these strategies, we may experience margins that are similar to or lower than our past margins.
Research and development expenses
Research and development expenses consist primarily of salary and benefits for research and development personnel who design and develop future products and product enhancements. Research and development also includes expenses associated with product design and development, the Compact Particle Acceleration Corporation (CPAC) proton therapy research project, customer research collaborations and fees to third parties who furnish services related to these activities.

 

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We expect research and development expenses to increase during 2010 as compared to 2009, both in dollars and as a percentage of total revenue, as we intend to increase our spending to support our ongoing product development initiatives. In addition, we expect to capitalize fewer software development costs related to ongoing product development projects in 2010 as compared to 2009, and we expect CPAC’s expenses to increase during 2010, provided it obtains additional funding.
Selling, general and administrative expenses
Selling, general and administrative expenses consist of salary and benefits for executive management, sales, marketing and other corporate functions. Also included in these expenses are travel, sales commissions, trade shows and marketing materials and expenses related to accounting, legal, tax and other consulting fees.
We expect 2010 selling, general and administrative expenses to increase in both dollars and as a percentage of total revenue as compared to 2009, as we intend to increase our selling and marketing expenses to further promote our products to our targeted markets. In addition, we expect to increase our general and administrative spending, as we plan to add resources to meet the requirements of our corporate functions.
Nonoperating expenses
Because we conduct business in numerous foreign jurisdictions, we are exposed to changes in foreign currency exchange rates. Foreign currency exchange rate fluctuations could materially adversely affect our business, financial condition and results of operations. Our primary exposures are related to foreign currency denominated sales and expenses in Europe. As of March 31, 2010, we did not have a hedging program in place to offset these risks.
Interest income
We expect interest income to decline in 2010 as compared to 2009, due to both lower levels of investable cash and reduced interest rates.
Income tax expense (benefit)
We are subject to taxation in the United States and in numerous foreign jurisdictions. Significant judgments and estimates are required when evaluating our tax positions and determining our worldwide provision for income taxes. As a result, our effective tax rate may fluctuate based on a number of factors including variations in projected taxable income in the numerous geographic locations in which we operate, changes in the valuation of our deferred tax assets, tax positions taken on tax returns filed in the geographic locations in which we operate, introduction of new accounting standards and changes in tax liabilities to address potential tax exposures related to business and income tax positions we have taken that could be challenged by taxing authorities.
When deemed necessary, valuation allowances are established to reduce deferred tax assets to amounts more-likely-than-not to be realized. This requires an assessment of both positive and negative evidence when determining whether it is more-likely-than-not that deferred tax assets will be realized. Evidence considered during the first three months of 2010 included the existence of cumulative three-year losses, a decreased backlog, projected current year losses and the negative impact of current economic conditions, which resulted in the recording of a valuation allowance to offset net deferred tax assets in domestic and certain foreign taxing jurisdictions.
Noncontrolling interests
Our condensed consolidated financial statements include the accounts of CPAC. Although Tomo’s ownership in CPAC is less than 50%, it has consolidated CPAC, as Tomo is the primary beneficiary of CPAC, due to its overall control of CPAC’s activities and Tomo’s ownership interest in CPAC. Therefore, CPAC’s outside stockholders’ interests are shown in our condensed consolidated financial statements as “Non-controlling interests.” If CPAC obtains additional funding, we expect our ownership percentage to continue to decline.

 

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Results of Operations
The following table sets forth certain elements from our condensed consolidated statements of operations as a percentage of revenue for the periods indicated:
                 
    Three Months Ended March 31,  
    2010     2009  
Revenue:
               
Product
    69.5 %     69.0 %
Service and other
    30.5       31.0  
 
           
Total revenue
    100.0       100.0  
 
           
Cost of revenue:
               
Product
    30.4       38.4  
Service and other
    39.6       53.3  
 
           
Total cost of revenue
    70.0       91.7  
 
           
Gross profit
    30.0       8.3  
 
           
Operating expenses:
               
Research and development
    17.9       19.1  
Selling, general and administrative
    26.2       34.8  
 
           
Total operating expenses
    44.1       53.9  
 
           
Loss from operations
    (14.1 )     (45.6 )
Other income
    0.2       1.4  
 
           
Loss before income tax
    (13.9 )     (44.2 )
Income tax benefit
    0.1       0.3  
 
           
Net loss
    (13.8 )%     (43.9 )%
 
           
 
               
Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009
Revenue
Revenue by major type for the three months ended March 31, 2010 and 2009 was as follows (in thousands):
                                 
    Three Months Ended March 31,  
    2010     2009  
Product revenue
  $ 29,229       69.5 %   $ 21,133       69.0 %
Service and other revenue
    12,851       30.5       9,490       31.0  
 
                       
 
  $ 42,080       100.0 %   $ 30,623       100.0 %
 
                       
Revenue by geographic region for the three months ended March 31, 2010 and 2009 was as follows (in thousands):
                                 
    Three Months Ended March 31,  
    2010     2009  
Americas (1)
  $ 13,333       31.7 %   $ 18,239       59.6 %
Europe and Middle East
    19,563       46.5       6,275       20.5  
Asia-Pacific
    9,184       21.8       6,109       19.9  
 
                       
 
  $ 42,080       100.0 %   $ 30,623       100.0 %
 
                       
     
(1)  
Americas contains revenue from the United States of $12.7 million and $17.6 million for the periods ended March 31, 2010 and 2009, respectively.
Product revenue increased $8.1 million, or 38%, between periods. The increase was primarily due to a higher number of Systems installed and accepted during the three months ended March 31, 2010 versus the three months ended March 31, 2009. Also contributing to the increase was a $2.8 million increase in revenue due to higher average selling prices of the System during the first quarter of 2010 compared to the first quarter of 2009, resulting from a higher volume of sales in Europe and the Middle East, which typically carry higher average selling prices.
Service and other revenue increased $3.4 million, or 35%, between periods. This increase was primarily attributable to an increase in service contract revenue, as more Systems moved from warranty to service contract coverage. There were 43% more units covered by service contracts at March 31, 2010 as compared to March 31, 2009. The number of distributor sites under service contract increased more significantly than our direct service contracts. Service contracts for distributor sites provide coverage for parts only and, therefore, are priced lower than our direct service contracts.

 

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Cost of revenue
Cost of revenue increased to $29.5 million for the three months ended March 31, 2010 from $28.1 million for the three months ended March 31, 2009, an increase of $1.4 million, or 5%, primarily due to increased System sales in the current quarter.
Manufacturing period expenses decreased by $0.8 million for the three months ended March 31, 2010 as compared to the three months ended March 31, 2009. This decrease was primarily due to an increase in manufacturing activity during the period, which led to an increase in absorbed costs.
Total service and support costs increased by $0.4 million for the three months ended March 31, 2010 compared to the three months ended March 31, 2009. Although there was a $2.6 million increase in our overall service contract costs during the first quarter of 2010, due to the larger number of units under service contract at March 31, 2010 as compared to March 31, 2009, such increase was partially offset by a $2.2 million decline in service infrastructure costs, as labor and overhead costs absorbed increased $1.1 million, costs associated with component and software upgrades to the installed base and related projects decreased $0.6 million, and employee costs decreased $0.5 million.
Warranty expenses increased $0.2 million for the three months ended March 31, 2010 compared to the three months ended March 31, 2009 due to more Systems being installed and accepted in the current quarter.
Research and development expenses
Research and development expenses by category for the three months ended March 31, 2010 and 2009 were as follows (in thousands):
                                 
    Three Months Ended March 31,  
    2010     2009     $ Change     % Change  
System R&D
  $ 6,643     $ 5,581     $ 1,062       19.0 %
Proton Project / CPAC R&D
    897       268       629       234.7  
 
                       
 
  $ 7,540     $ 5,849     $ 1,691       28.9 %
 
                       
Total research and development expenses increased $1.7 million, or 29%, between periods. System research and development activities increased by $1.1 million between periods primarily due to a $0.8 million decrease in capitalization of internal development costs related to certain software options, which were completed and released for delivery in February 2010. The proton therapy research project spending increased by $0.6 million during the three months ended March 31, 2010, due mainly to a $0.3 million increase in consultant fees, as CPAC expanded its development activities during the first quarter of 2010 upon receipt of new project funding.
Selling, general and administrative expenses
Selling, general and administrative expenses increased to $11.0 million for the three months ended March 31, 2010 from $10.7 million for the three months ended March 31, 2009, an increase of $0.3 million, or 4%. The increase was primarily due to higher commissions as more Systems were installed and accepted during the three months ended March 31, 2010 compared to the three months ended March 31, 2009.
Other income (expense)
Other income decreased to $0.1 million for the three months ended March 31, 2010 from $0.4 million for the three months ended March 31, 2009. The decline was primarily due to a $0.2 million decrease in interest income as our average investment balances and interest rates were lower during the first quarter of 2010 as compared to 2009.
Income tax expense (benefit)
For the three months ended March 31, 2010, we recorded an income tax benefit of $0.04 million resulting in an effective income tax rate of 0.7%. Our effective tax rate for the first quarter of 2010 differed significantly from the statutory tax rate primarily due to recording a valuation allowance for deferred tax assets in domestic and certain foreign taxing jurisdictions that are not more-likely-than-not to be realized. For the three months ended March 31, 2009, we recorded an income tax benefit of $0.1 million resulting in an effective income tax rate of 0.7%.

 

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Liquidity and Capital Resources
To date, we have funded our working capital and capital expenditure requirements using cash generated from sales of equity securities, operations and, to a lesser extent, borrowings. From our inception through March 31, 2010, we obtained financing of $235.5 million primarily through public and private placements of equity securities and the exercise of stock options.
Financial Condition
Our cash, cash equivalents and short-term investments were $148.7 million at March 31, 2010 compared to $154.3 million at December 31, 2009, a decrease of $5.6 million, or 4%. Information regarding short-term investments, which totaled $56.6 million at March 31, 2010, is set forth in the following table (in thousands):
                                 
    March 31, 2010  
    Cost basis     Unrealized gains     Unrealized losses     Fair value  
U.S. Government and Agency securities
  $ 43,456     $ 813     $     $ 44,269  
Corporate bonds
    12,099       264             12,363  
 
                       
 
  $ 55,555     $ 1,077     $     $ 56,632  
 
                       
We entered into a $40 million revolving credit facility during 2009, under which there were no borrowings as of March 31, 2010. This line of credit is currently set to expire on November 30, 2010. The facility requires us to maintain a minimum tangible net worth, a specified ratio of total liabilities to tangible net worth and a minimum level of cash and short-term investments. We were in compliance with these covenants at March 31, 2010. In addition, the facility provides for an adjusted credit limit based on a certain level of tangible net worth and earnings before interest, taxes, depreciation and amortization. Based on our levels as of March 31, 2010, the adjusted credit limit remains unchanged at $30 million. Under the terms of the credit facility, we may be considered in default upon a material adverse change in our financial condition or if the bank believes the prospect of payment or performance of the facility is impaired.
Our working capital, which is calculated by subtracting our current liabilities from our current assets, was $164.1 million at March 31, 2010 compared to $161.8 million at December 31, 2009, an increase of $2.3 million or 1%. Our shareholders’ equity was $180.8 million at March 31, 2010 compared to $183.4 million at December 31, 2009, a decrease of $2.6 million or 1%. The increase in our working capital was primarily due to CPAC funding received during the first quarter of 2010. The decrease in our shareholders’ equity was primarily caused by our operating loss during the first three months of 2010.
Cash Flows
Cash flows from operating activities
Net cash used in operating activities was $11.1 million for the three months ended March 31, 2010. This included a net loss of $5.9 million, which was adjusted for the following noncash items: $2.5 million in depreciation and amortization and $1.8 million in share-based compensation. Receivables increased marginally by $0.2 million due to new billings in 2010 related to ongoing operations, partially offset by the collection of 2009 year-end balances. Inventory increased by $6.1 million due to increased stocking levels to meet production needs at March 31, 2010 compared to December 31, 2009. Accounts payable increased $5.5 million as our inventory purchasing activity increased during the first quarter of 2010. Accrued expenses decreased by $2.9 million due primarily to the payment of year-end accrued payroll, severance and commissions as well as reduced warranty accruals due to decreased average costs per site. Deferred revenue decreased by $2.0 million, due largely to a change in the mix of Systems awaiting customer acceptance, and customer deposits decreased by $2.7 million, due mainly to the increase in shipments during the first three months of 2010.
Net cash used in operating activities was $1.6 million for the three months ended March 31, 2009. This included a net loss of $13.4 million, which was adjusted for the following noncash items: $2.4 million in depreciation and amortization, $1.5 million in share-based compensation and $0.2 million in deferred income tax benefits. Receivables decreased by $8.5 million due to collections of year-end balances and a lower number of System acceptances. Inventory increased by $0.8 million due to the number of in-process Systems being built in anticipation of our second quarter shipment schedule. Accounts payable increased by $3.3 million, as our inventory purchasing activity increased during the period. Accrued expenses decreased by $3.7 million due primarily to the decreases of payroll, severance, commission and warranty accruals. Deferred revenue increased by $2.2 million due largely to an increase in deferred service contract revenue, as more customers entered into service contracts due to growth in the installed system base. Customer deposits decreased by $0.8 million due to a lower number of new orders received during the first quarter of 2009.

 

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Cash flows from investing activities
Net cash provided by investing activities was $19.8 million for the three months ended March 31, 2010, as we received approximately $21.3 million in proceeds from the sales and maturities of short-term investments. These proceeds were partially offset by $1.2 million in purchases of capital equipment, which included tools and equipment to support our operations and new computer equipment and software.
Net cash used in investing activities was $4.7 million for the three months ended March 31, 2009, as we invested $7.5 million in short-term investments and $1.2 million in capital equipment, which included tools and equipment to support our operations and new computer equipment and software. In addition, we capitalized $0.9 million of internal development costs related to new software products. Partially offsetting these investments, we sold $4.9 million of our short-term investments during the period.
Cash flows from financing activities
Net cash provided by financing activities was $7.1 million for the three months ended March 31, 2010, primarily due to $6.5 million in proceeds from third-party investors related to the issuance of CPAC common stock and, to a lesser extent, the exercise of equity-based awards by our employees.
Net cash provided by financing activities was $6.3 million for the three months ended March 31, 2009, primarily due to $6.4 million in proceeds from third-party investors related to the issuance of CPAC common stock.
The effect of foreign currency exchange rate changes on cash and cash equivalents resulted in an increase of $0.2 million during the three months ended March 31, 2010. During the three months ended March 31, 2009, the effect of foreign currency exchange rate changes on our cash and cash equivalents resulted in a increase of $0.7 million.
Loans and Available Borrowings
There have been no significant changes to the loans and available borrowings we reported in our Annual Report on Form 10-K for the year ended December 31, 2009.
Contractual Obligations and Commitments
There have been no significant changes to the contractual obligations and commitments we reported in our Annual Report on Form 10-K for the year ended December 31, 2009.
Pending Litigation
On May 30, 2008 and June 10, 2008, two separate complaints were filed by certain of our shareholders in the U.S. District Court for the Western District of Wisconsin (the Court) against us and certain of our officers and all of our independent directors during the period in question. The complaints were consolidated on October 23, 2008. The consolidated action alleges that the defendants violated the Securities Act of 1933 (Securities Act) with respect to statements made in connection with the initial and secondary public offerings of our common stock and the Securities Exchange Act of 1934 (Exchange Act) by misrepresenting our projected financial outlook during the period May 9, 2007 through April 17, 2008. The named plaintiffs, Michael Schultz, John Scala, et al., seek to represent persons who purchased our securities between those dates and who were damaged as a result of the decline in the price of our stock between those dates, allegedly attributable to the financial misrepresentations, and seek compensatory damages in an unspecified amount.
We moved to dismiss the consolidated complaint on December 8, 2008. On July 9, 2009, the Court ruled on the motion to dismiss the consolidated complaint by dismissing without prejudice all claims under the Exchange Act and all but one claim under the Securities Act for failure to state a claim upon which relief could be granted. On August 3, 2009, the plaintiffs amended the consolidated complaint by filing their Second Amended Consolidated Complaint (the Amended Complaint). We moved to dismiss the Amended Complaint on September 3, 2009, and on December 15, 2009 the Court granted this second motion to dismiss in part and denied it in part. The plaintiffs have moved for class certification and briefing on that motion is ongoing. We continue to believe that we have substantial legal and factual defenses to the allegations contained in the Amended Complaint, and we intend to pursue these defenses vigorously. There can be no assurance, however, that we will prevail. Although we carry insurance for these types of claims and related defense costs, a judgment significantly in excess of our insurance coverage could materially and adversely affect our financial condition, results of operations and cash flows. As of March 31, 2010, we estimated that our potential loss from these claims and related defense costs will not exceed our insurance deductible of $0.5 million.

 

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Reserve for Contingency
On July 17, 2009, Hi-Art Co., Ltd. (Hi-Art), our former distributor in Japan, filed a complaint against us in the Tokyo District Court seeking compensation it claims is owed by us. Although we believe that we have substantial legal and factual defenses to Hi-Art’s allegations and intend to pursue these defenses vigorously, there can be no assurance that we will prevail. Accordingly, we maintain a reserve with respect to this matter.
Operating Capital and Capital Expenditure Requirements
Our future capital requirements depend on numerous factors. These factors include, but are not limited to, the following:
   
Revenue generated from sales of the System and service contracts;
   
The performance of the System operating in the field and corresponding service costs;
   
The level of investment required by our service and support organization;
   
The level of investment required for research and development activities;
   
Costs associated with our manufacturing, sales and marketing and general and administrative activities; and
   
Effects of competing technological and market developments.
The global economy remains volatile and could have potentially negative effects on our near-term liquidity and capital resources, including slower collections of receivables, delays in the delivery of existing orders and postponements of incoming orders. However, we believe that our cash and short-term investments as of March 31, 2010, along with the cash we expect to generate from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. As of March 31, 2010, we had $148.7 million of cash and short-term investments. We do not expect to draw on our $30 million line of credit, and we believe our financial position will remain strong throughout 2010. Moreover, we continue to manage our cash resources and are carefully monitoring our ongoing expenditures.
Off-Balance Sheet Arrangements
As of March 31, 2010, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of our financial condition and results of operations is based on our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of these condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base these estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
For a description of our critical accounting policies and estimates, please refer to the “Critical Accounting Policies and Estimates” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2009.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued new accounting guidance on fair value measurements and disclosures. The new guidance defines fair value, establishes a framework for measuring fair value under U.S. GAAP and enhances disclosures about fair value measurements. In February 2008, the FASB issued further guidance, which provided a one year deferral of the effective date for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. This guidance applies under other accounting pronouncements that require or permit fair value measurements, as the FASB previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this guidance does not require any new fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The adoption of the new guidance in 2008 and the further guidance in 2009 did not have a material impact on our condensed consolidated financial statements.

 

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In June 2009, the FASB issued revised guidance for the accounting of variable interest entities. This revised guidance replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and has the obligation to absorb losses or the right to receive benefits from the entity that could be potentially significant to the variable interest entity. The accounting guidance also requires an ongoing reassessment of whether an enterprise is the primary beneficiary and requires additional disclosures about an enterprise’s involvement in variable interest entities. The adoption of this accounting guidance, which became effective for us beginning in the first quarter of fiscal 2010, did not have a material impact on our condensed consolidated financial statements.
In September 2009, the FASB amended the accounting guidance on revenue recognition. Under the amended guidance, consideration in a multiple element arrangement may now be allocated in a manner that more closely reflects the structure of the transaction (“new revenue guidance”). Also, under the new revenue guidance, tangible products that contain software components essential to the functionality of the tangible product will no longer be subject to software revenue recognition guidance and will now be subject to other revenue guidance. The new revenue guidance allows for early or retrospective adoption and will be required as of January 1, 2011. We elected to early adopt this new revenue guidance at the beginning of fiscal 2010 on a prospective basis for applicable transactions originating or materially modified on or after January 1, 2010; we do not expect the adoption of the new revenue guidance will have a material impact on our consolidated financial statements.
Item 3.  
Quantitative and Qualitative Disclosures about Market Risk
Our exposure to market risk is currently confined to changes in short-term investments, foreign currency exchange and interest rates. Our exposure to market risk was discussed in Item 7A. “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the year ended December 31, 2009. There have been no material changes to such exposure since December 31, 2009.
Item 4.  
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2010. Management has concluded that the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, our financial position, results of operations and cash flows in conformity with U.S. GAAP.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended March 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Part II. OTHER INFORMATION
Item 1.  
Legal Proceedings
We are subject to various claims and legal proceedings arising in the ordinary course of our business. The description of the developments with respect to the pending securities class action is incorporated herein by reference to Note G to our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. We believe that the ultimate resolution of the various claims and legal proceedings to which we are subject will not have a material adverse effect on our business, financial condition or results of operations.
Item 1A.  
Risk Factors
In addition to the risk factors set forth below and the other information set forth in this report, you should carefully consider the factors discussed in “Part I, Item 1A. Risk Factors” in our 2009 Annual Report on Form 10-K, which could materially affect our business, financial condition or results of operations. Important factors that could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by statements in this Quarterly Report on Form 10-Q include, but are not limited to, the risk factors discussed below or in “Part I, Item 1A. Risk Factors” in our 2009 Annual Report on Form 10-K. If any of the events discussed in such risk factors occur, our business, financial condition and results of operations could be adversely affected in a material way, and the market value of our common stock could decline.
We face competition from numerous competitors, many of which have greater resources than we do, which may make it more difficult for us to achieve significant market penetration and maintain or increase our prices.
The market for radiation therapy equipment is characterized by intense competition and pricing pressure. We consider the competition for the TomoTherapy treatment systems to be existing radiation therapy systems, primarily using C-arm linear accelerators, sold by large, well-capitalized companies with significantly greater market share and resources than we have. Several of these competitors are also able to leverage their fixed sales, service and other costs over multiple products or product lines. In particular, we compete with a number of existing radiation therapy equipment companies including Varian Medical Systems, Inc., Elekta AB, Siemens Medical Solutions, and, to a lesser extent, Accuray Incorporated and BrainLAB AG. Varian Medical Systems has been the radiation therapy systems market leader for many years and has the majority market share for radiation therapy systems worldwide. In 2008, Varian began selling and installing the RapidArc technology. The RapidArc technology purports to be able to deliver image-guided, intensity-modulated radiation therapy more rapidly than other similar systems, including the Hi Art system, and Varian has maintained a strong marketing campaign claiming this technology has the same capabilities as, or better capabilities than, our Hi Art system. On April 14, 2010, Varian announced the launch of a new line of accelerators it refers to as the TrueBeam platform, which Varian claims are systems specifically designed for high-precision image-guided radiotherapy and radiosurgery. Varian claims this new platform is designed to be versatile and can be used for all forms of advanced external-beam radiotherapy. If we are unable to compete effectively with these and other products of existing or future competitors, our revenue will decline, and there could be a material adverse effect on our business, financial condition and results of operations. Some of our competitors may compete by changing their pricing model or by lowering the price of their conventional radiation therapy systems or ancillary supplies. If such pricing strategies are implemented, there could be downward pressure on the price of radiation therapy systems. If we are unable to maintain or increase our selling prices, our gross margins will decline, and there could be a material adverse effect on our business, financial condition and results of operations.
Changes in healthcare policies and laws resulting from recent passage of the new healthcare law in the United States could adversely affect our business.
In the United States, healthcare reform legislation was passed and signed into law in March 2010 in the form of the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010 (the Healthcare Reform Law). The Healthcare Reform Law imposes some new requirements on medical device manufacturers and may present other new issues, some of which will be better understood as implementing regulations are issued. For example, beginning January 1, 2013, we will be required to pay a 2.3% excise tax on our medical device sales, which could impact our pricing or profitability. We will need to establish systems and controls to ensure compliance with new transparency requirements relating to payments and other transfers of value to certain of our customers for values of $10 or more (or $100 in aggregate value in a calendar year), with the obligation to report such payments beginning January 1, 2013 for payments made in 2012. We also will need to understand and respond to comparative effectiveness research activities initiated under the Healthcare Reform Law that could impact the use of our products. If we are unable to respond effectively to these and other impacts of the Healthcare Reform Law, as refined by subsequent regulations, our sales could decline and our costs could increase in the United States, which could have a material adverse effect on our business, financial condition and results of operations.

 

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Changes in reimbursement to healthcare providers for use of the TomoTherapy treatment system could adversely affect sales of the TomoTherapy treatment system.
Our ability to market and sell the TomoTherapy treatment system successfully depends in part on the extent to which sufficient reimbursement for treatment procedures using the TomoTherapy treatment system will be available from third-party payors such as private health insurance plans and health maintenance organizations and government payor programs such as Medicare and Medicaid. Third-party payors, and in particular managed care organizations, challenge the prices charged for medical products and services and institute cost containment measures to control or significantly influence the purchase of medical products and services. For example, in November 2009, the United States Centers for Medicare and Medicaid Services, or CMS, issued new reimbursement rates for 2010. For 2010, CMS increased rates slightly for hospitals and implemented only modest reimbursement rate decreases for free-standing clinics. However, CMS reviews such rates annually, and could implement more significant changes in 2011 and future years. If in the future CMS significantly decreases reimbursement rates for radiation oncology services, or if other cost containment measures are implemented in the United States or elsewhere, clinicians may be reluctant to purchase TomoTherapy treatment systems or may decline to do so entirely if they determine there is insufficient coverage and reimbursement from third-party payors for the cost of procedures performed, which could have an adverse impact on our sales.
Our success in non-U.S. markets also depends upon treatment procedures using our products being eligible for reimbursement through government-sponsored healthcare payment systems, private third-party payors and labor unions. Reimbursement and healthcare payment systems in international markets vary significantly by country and, within some countries, by region. In many international markets, payment systems may control reimbursement for procedures performed using new products as well as procurement of these products. In addition, as economies of emerging markets develop, these countries may implement changes in their healthcare delivery and payment systems. Healthcare cost containment efforts are prevalent in many of the countries in which we sell, or intend to sell, our products, and these efforts are expected to continue. Market acceptance of TomoTherapy treatment systems in a particular country may depend on the availability and level of reimbursement in that country. Our ability to generate sales may be adversely affected if customers are unable to obtain or maintain adequate reimbursement for treatment procedures using our products in markets outside of the United States
Our sales and receivables may be adversely impacted if current economic conditions persist or worsen, or credit becomes more difficult to obtain on reasonable terms.
The TomoTherapy treatment systems are major capital equipment items that represent a significant purchase for most of our customers and may require funding through a credit facility or lease arrangement. If the global economy is weak, our customers may hesitate to place large capital equipment orders for items such as the TomoTherapy treatment systems or they may be required to delay or cancel previously planned purchases. Our customers may also be slower to pay, thereby increasing receivables. A number of orders we expected to receive in 2009 have not been placed because of certain hospitals’ freezes on capital equipment purchases. Although there are some early indications that the U.S. economy may be improving, whether and when it will improve significantly remains uncertain at the time of this filing. In Europe, the governments of certain countries such as Greece and Portugal are struggling under heavy debt obligations that may impact their economies and those of other countries in the European Union. If macroeconomic conditions continue to be poor, our customers may purchase fewer TomoTherapy treatment systems, we may need to reduce our prices or our customers may have difficulty paying us, any of which could have a material adverse effect on our business, financial condition and results of operations.
Modifications, upgrades and future products related to the System may require new FDA premarket approvals or 510(k) clearances, and such approval or clearance processes may be different than in the past, which may impact our ability to market and sell both new and existing products.
The Systems are medical devices that are subject to extensive regulation in the United States and elsewhere, including by the FDA and its foreign counterparts. Before a new medical device, or a significant change involving a new use of or claim for an existing medical device, can be marketed in the United States, it must first receive either premarket approval or 510(k) clearance from the FDA, unless an exemption exists. Either process can be expensive and lengthy. The FDA’s 510(k) clearance process has in the past usually taken from three to twelve months, but can last longer. The process of obtaining premarket approval is much more costly and uncertain than the 510(k) clearance process and generally takes from one to three years, or even longer, from the time the application is filed with the FDA. An element of our strategy is to continue to upgrade the System to incorporate new software and hardware enhancements that may require the approval of or clearance from the FDA or its foreign counterparts. The FDA requires medical device manufacturers to determine whether or not a modification requires an approval or clearance. In the past, any modification to an FDA approved or cleared device that would significantly affect its safety or efficacy or that would constitute a major change in its intended use would require a new premarket approval or 510(k) clearance. Certain upgrades previously released by us required 510(k) clearance before we were able to offer them for sale. We have made modifications to the Hi Art system in the past and may make additional modifications to our products in the future that we believe do not or will not require additional approvals or clearances.

 

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The FDA and its foreign counterparts may change these policies, adopt additional regulations, or revise existing regulations, each of which could prevent or delay premarket approval or 510(k) clearance of our new or modified devices, or could impact our ability to market our currently cleared devices. The FDA, for example, has recently sent letters to all manufacturers of radiation therapy treatment systems, including TomoTherapy, announcing its intention to review the 510(k) process and consider enhancements that could impact future 510(k) submissions. It has also encouraged manufacturers to consult with the FDA as to the appropriate 510(k) clearance process for any new product. Such changes could result in additional scrutiny by the FDA of 510(k) applications that we submit and could result in delays and increased costs in obtaining FDA clearances, which could materially impact our business, financial condition and results of operations.
Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
(a) Sales of Unregistered Securities
None.
(b) Use of Proceeds from Public Offering of Common Stock
Our initial public offering of 13,504,933 shares of our common stock, par value $0.01 per share, was effected through a Registration Statement on Form S-1 (Reg. No. 333-140600), which was declared effective by the Securities and Exchange Commission on May 8, 2007. We issued 10,602,960 shares on May 9, 2007 and received gross proceeds of $201.5 million. We paid the underwriters a commission of $14.1 million and incurred additional offering expenses of approximately $2.7 million. After deducting the underwriters’ commission and the offering expenses, we received net proceeds of approximately $184.7 million. The managing underwriter of our initial public offering was Merrill Lynch & Co. In addition, 2,901,973 shares were sold by selling shareholders, 1,761,513 of which were purchased by the underwriters’ exercise of their overallotment option.
No payments of underwriters’ commissions or offering expenses were made directly or indirectly to (i) any of our directors, officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity securities, or (iii) any of our affiliates.
Through March 31, 2010, we used $95.4 million of the net proceeds from our initial public offering, as detailed in the following table (in millions):
         
Working capital
  $ 70.7  
Purchases of property and equipment
    17.2  
Purchases of test systems
    5.7  
Acquisition of Chengdu Twin Peak Accelerator Technology Inc.
    1.5  
Repayment of debt
    0.3  
 
     
Total net proceeds used
  $ 95.4  
 
     
(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Item 3.  
Defaults Upon Senior Securities
None.
Item 4.  
[Removed and Reserved]
Item 5.  
Other Information
None.

 

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Item 6.  
Exhibits
         
Exhibit Number   Description
       
 
  3.1 (1)  
Amended and Restated Articles of Incorporation of the Company
       
 
  3.2 (1)  
Amended and Restated Bylaws of the Company
       
 
  31.1 *  
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2 *  
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1 *  
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  32.2 *  
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
     
(1)  
Previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 7, 2008 (File No. 001-33452).
 
*  
Filed herewith.

 

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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, TomoTherapy Incorporated has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  TOMOTHERAPY INCORPORATED
 
 
Date: May 6, 2010  By:   /s/ Frederick A. Robertson    
    Frederick A. Robertson   
    Chief Executive Officer and President   
     
Date: May 6, 2010  By:   /s/ Thomas E. Powell    
    Thomas E. Powell   
    Chief Financial Officer and Treasurer   

 

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EXHIBIT INDEX
         
Exhibit Number   Description
  3.1 (1)  
Amended and Restated Articles of Incorporation of the Company
       
 
  3.2 (1)  
Amended and Restated Bylaws of the Company
       
 
  31.1 *  
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2 *  
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1 *  
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  32.2 *  
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
     
(1)  
Previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 7, 2008 (File No. 001-33452).
 
*  
Filed herewith.

 

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