As filed with the Securities and Exchange Commission on April 19, 2007

Registration No. 333-140600

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

AMENDMENT NO. 3

to

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

 

 

1240 Deming Way

Madison, Wisconsin 53717

(608) 824-2800

(Address, including zip code, and telephone number,

including area code, of registrant’s principal executive offices)

 

 

 

 

Stephen C. Hathaway

Chief Financial Officer and Treasurer

1240 Deming Way

Madison, Wisconsin 53717

(608) 824-2800

(Name, address, including zip code, and telephone number,

including area code, of agent for service)

 

 

 

 

 

 

 

 

Approximate date of commencement of proposed sale to the public:   As soon as practicable after the effective date of this registration statement.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box:   o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

 

 

TABLE OF CONTENTS

 

 

 

You should rely only on the information contained in this prospectus and any free writing prospectus prepared by or on our behalf. We have not, and the underwriters have not, authorized anyone to provide you with information different from, or in addition to, that contained in this prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

SUMMARY

	•	Intensity Modulated Radiation Therapy (IMRT) , which varies the radiation beam intensity to conform the dose more accurately to the shape of the tumor;
	•	Image Guided Radiation Therapy (IGRT) , which involves delivering IMRT guided by images taken shortly before treatment to compare the patient’s position to, and make adjustments from, the original treatment plan for more precision;
	•	Dose escalation , which involves delivering the cumulative prescribed dose of radiation to the patient over less than the typical number of treatment sessions by relying on extremely precise targeting to deliver a higher dose of radiation during each session; and
	•	Adaptive radiation therapy , which we believe requires continual adjustments to the treatment plan throughout the entire course of treatment, facilitated by both the regular acquisition of updated images showing the location, geometry and density of the tumor, as well as verification of the actual radiation dose received by the patient.

	•	Limited versatility and precision.   The limited speed and range of C-arm gantries used by most other systems often make it impractical to deliver radiation from more than five to nine treatment angles during a typical treatment session. These mechanical limitations reduce the system’s ability to deliver precisely targeted radiation that avoids healthy tissue.

	•	Limited ability to provide frequent, quantitative images.   Many traditional radiation therapy systems either do not incorporate CT imaging functionality or use imaging technologies that do not have the ability to generate daily, quantitative images. Since it is common for internal organs to shift and for the size of the tumor to change during the course of treatment, failure to obtain updated images and adapt the treatment plan throughout the course of treatment may result in a portion or potentially all of the radiation dose missing the tumor and instead being absorbed by healthy tissue.

	•	Failure to integrate multiple functions.   Many traditional radiation therapy systems were designed solely for the purpose of delivering radiation and therefore do not possess integrated imaging, treatment planning, dose verification or quality assurance capabilities necessary for more advanced treatment protocols.

	•	More versatile treatment capabilities.   The Hi Art system’s high-speed ring gantry and beam- shaping capability allow the intensity of the radiation beam to be modified and treatment to be delivered continuously in a helical pattern 360 degrees around the patient’s body from thousands of angles without extending the time it takes to complete the procedure.

	•	Daily, quantitative imaging for better identification of tumors, dose verification and treatment planning.   The Hi Art system is the only commercially available radiation therapy system offering integrated quantitative CT imaging capabilities, which we market as our CTrue technology, which depict the density of tumors and healthy tissue more accurately than traditional radiation therapy systems. We believe that daily, quantitative images are necessary for the accurate delivery of IMRT and are essential to optimizing a patient’s treatment by enabling clinicians to adapt the treatment plan in response to anatomical changes and the cumulative amount of radiation received by specific areas within the patient over time.

	•	Fully integrated treatment system for more precise radiation delivery.   We believe that the integration of our CTrue imaging technology, treatment planning and helical delivery of radiation beams shaped by the MLC enables highly precise radiation delivery to ensure that the radiation conforms to the patient’s tumor and avoids sensitive structures. We also believe these features significantly benefit patients by providing a precisely-targeted dose distribution which maximizes the radiation delivered to cancerous tissues and minimizes damage to healthy tissues.

	•	Efficient clinical workflow for IGRT and adaptive radiation therapy.   We believe that the Hi Art system allows clinicians to easily and rapidly scan, plan and treat cancer patients. This capability enables healthcare providers to increase patient throughput for sophisticated IGRT and adaptive radiation therapy procedures using the Hi Art system.

	•	Low barriers to installation and implementation.   The Hi Art system’s compact design, with built-in shielding, allows customers to retrofit the Hi Art system into existing treatment rooms and avoid or reduce the significant construction costs that can be associated with the installation of other systems. We preassemble, test and commission each Hi Art system at our manufacturing facility and ship the unit almost fully assembled. This assembly process allows radiation “beam-on” within four days and treatments to begin within 45 days of delivery in most cases.

	•	Platform for further technological advancements in adaptive radiation therapy.   We believe that the Hi Art system is the only commercially available linear accelerator that enables adaptive radiation therapy because of its unique ability to provide daily, quantitative images, high speed delivery of radiation from 360 degrees around the body and the data necessary for clinicians to verify the actual radiation dose received by the patient. We also believe that the combination of these design features and our integrated treatment planning and optimization software will allow us to continue to enhance the Hi Art system’s adaptive capabilities to a point where clinicians can routinely and easily adjust a patient’s treatment as needed.

	•	Increase market awareness of the Hi Art system’s clinical and economic benefits.   In order to expand our installed base of Hi Art systems, we intend to continue to position the Hi Art system as the most advanced radiation therapy system for treating a wide range of cancers effectively and efficiently.

	•	Expand our worldwide sales presence.   We intend to add additional direct sales representatives to better penetrate the United States market, while further investing in direct and indirect sales and marketing efforts in international markets.
	•	Increase our profitability through cost reductions and improved operating leverage.   In order to increase our profitability, we will seek to decrease our reliance on single-source suppliers of key components in order to enable us to negotiate better prices with a wider range of suppliers and to improve component reliability. In addition, a number of opportunities exist to reduce costs through re-engineering higher cost components. We will also seek to increase our profitability as we leverage our investments in our global service and support infrastructure through increased sales volumes.
	•	Continue to enhance our customer service and support capabilities.   We intend to build upon our infrastructure and technology advantages by hiring additional support personnel, implementing regional training programs and expanding the number of local spare parts depots to continually augment and refine our customer service.
	•	Enhance the Hi Art system’s treatment capabilities through on-going research and development initiatives.   Our research and development initiatives are focused on more fully automating the treatment optimization process, thereby decreasing the time necessary for clinicians to develop and adapt treatment plans. We believe these enhancements will allow clinicians to increase patient throughput without compromising treatment plan quality and increase our customers’ return on their investment.

	•	We depend on the Hi Art system for substantially all of our revenue.
	•	The long sales cycle and high unit price of the Hi Art system, as well as other factors, may contribute to substantial fluctuations in our quarterly operating results and stock price.
	•	We face competition from numerous competitors, many of whom have greater resources than we do.
	•	Our reliance on single-source suppliers for critical components of the Hi Art system could harm our ability to meet demand for our products in a timely and cost-effective manner.
	•	Sales of the Hi Art system may be adversely affected if clinicians do not widely adopt IGRT and adaptive radiation therapy.
	•	We may be delayed or prevented from implementing our long-term sales strategy if we fail to educate clinicians about the benefits of the Hi Art system.
	•	If we are unable to satisfy the requirements of our licenses with the Wisconsin Alumni Research Foundation, or WARF, we could lose access to those licensed technologies and be unable to produce or sell the Hi Art system.

THE OFFERING

 

Common stock offered:
By TomoTherapy		10,200,000 shares
By the selling shareholders		737,500 shares
Shares to be outstanding after this offering		48,345,337 shares
Use of proceeds		We estimate that the net proceeds from this offering will be approximately $150.0 million after deducting underwriting discounts and estimated offering expenses. We intend to use the net proceeds from this offering to finance expanding our sales and marketing efforts, increasing our research and development programs, expanding our international service and support group, and for working capital and other general corporate purposes. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, products or technologies, although we currently do not have any acquisitions or investments planned. See “Use of Proceeds.” We will not receive any proceeds from the sale of shares by the selling shareholders.
Risk factors		See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.
Nasdaq Global Market Symbol		TTPY

	•	9,533,677 shares reserved for issuance under our stock option plans, of which options to purchase 7,231,189 shares of common stock at a weighted average exercise price of $3.97 per share had been granted; and
	•	10,039 shares reserved for issuance upon the exercise of outstanding warrants with an exercise price of $1.84 per share.

	•	1,288,669 shares issued for no consideration to certain holders of our Series A preferred stock, including certain members of our management and entities affiliated with our directors, pursuant to the Series A Investment Agreement;
	•	1,915,522 shares issued upon the exercise of stock options; and
	•	455,615 shares issued upon the exercise of warrants;

	•	reflects the conversion upon the closing of this offering of all of our shares of preferred stock on a one-for-one basis into shares of common stock;
	•	assumes an initial public offering price of $16.00 per share, the midpoint of the estimated initial public offering price range;
	•	assumes no exercise of the underwriters’ option to purchase from the selling shareholders up to 1,640,625 additional shares to cover overallotments; and
	•	reflects a 50-for-1 stock split effected on August 26, 2002, a 4-for-1 stock split effected on June 30, 2005, and a 1.36-for-1 stock split to become effective prior to the effectiveness of the registration statement of which this prospectus forms a part.

		Year Ended December 31,
		2004				2005				2006
		(in thousands, other than share and per share data)
Consolidated statements of operations data:
Revenue		$	45,460			$	75,754			$	156,102
Cost of revenue			28,078				50,047				102,653
Gross profit			17,382				25,707				53,449
Operating expenses:
Research and development			6,492				11,372				21,397
Selling, general and administrative			7,827				14,197				23,119
Total operating expenses			14,319				25,569				44,516
Income from operations			3,063				138				8,933
Other income (expense), net			(31	)			179				(1,202	)
Income before income tax and cumulative effect of change in accounting principle			3,032				317				7,731
Income tax expense (benefit)			151				78				(7,184	)
Income before cumulative effect of change in accounting principle			2,881				239				14,915
Cumulative effect of change in accounting principle(1)			—				—				(2,140	)
Net income			2,881				239				12,775
Accretion of redeemable convertible preferred stock(2)			(41,960	)			(68,075	)			(46,253	)
Net loss attributable to common shareholders		$	(39,079	)		$	(67,836	)		$	(33,478	)
Basic and diluted net loss per share attributable to common shareholders		$	(5.40	)		$	(8.48	)		$	(3.78	)
Weighted average common shares used in computing basic and diluted net loss per share attributable to common shareholders			7,234,229				7,995,629				8,855,870
Pro forma basic net income per share(3)										$	0.36
Pro forma diluted net income per share(3)										$	0.32
Pro forma weighted average number of shares used in computing basic net income per share(3)											35,365,778
Pro forma weighted average number of shares used in computing diluted net income per share(3)											40,130,383

(1)		Represents impact of the adoption of Staff Position 150-5, Issuer’s Accounting under Financial Accounting Standards Board (FASB) Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable (“FSP 150-5”). Pursuant to FSP 150-5, we are required to classify our outstanding warrants to purchase preferred stock as a liability on our balance sheet and record adjustments to their fair value in our statements of operations at the end of each reporting period. For the year ended December 31, 2006, the impact of the change in accounting principle was to decrease net income by $3.1 million, consisting of a $2.2 million cumulative effect adjustment for the change in accounting principle as of January 1, 2006, when the Company adopted FSP 150-5, and $0.9 million of expense that was recorded in other income (expense), net to reflect the increase in fair value between January 1, 2006 and December 31, 2006. The warrants will be subject to revaluation at each balance sheet date and any change in fair value will be recognized as a component of other income (expense), net, until the earlier of exercise of the warrants or the closing of this offering.
(2)		Accretion of redeemable convertible preferred stock represents the impact attributable to the increase in the fair market value of such shares. The holders of Series A, B, C and D preferred stock have the option to put their shares back to us at the greater of (i) the original purchase price plus accrued dividends, or

		(ii) the fair market value of the shares. The holders of Series E preferred stock have the option to put their shares back to us at the original purchase price plus accrued dividends. The put option and the related accretion of the preferred shares will terminate upon the closing of this offering.

(3)		Pro forma net income per share gives effect to the conversion upon the closing of this offering of all of our issued and outstanding shares of preferred stock on a 1-for-1 basis into shares of common stock. See Note A to our consolidated financial statements for an explanation of the number of shares used in computing per share data.

		As of December 31, 2006
										Pro forma as
		Actual				Pro forma				Adjusted
						(unaudited)				(unaudited)
		(in thousands)
Consolidated balance sheet data:
Cash and cash equivalents		$	20,137			$	20,137			$	170,113
Inventories			40,026				40,026				40,026
Working capital			7,446				7,446				157,422
Total assets			109,314				109,314				259,290
Deferred revenue and customer deposits			43,307				43,307				43,307
Redeemable convertible preferred stock			212,663				—				—
Total shareholders’ equity (deficit)			(184,117	)			28,546				178,522

 

Investment in our common stock involves a number of risks. You should carefully consider the risks and uncertainties described below and the other information included in this prospectus, before deciding to invest in shares of our common stock. If any of the following risks or uncertainties actually occurs, our business, prospects, financial condition and operating results would likely suffer, possibly materially. In that event, the market price of our common stock could decline and you could lose all or part of your investment. Additional risks and uncertainties presently unknown to us, or that we believe not to be material at this time, may also impair or have a material adverse effect on our operations.

 

Risks Related to Our Business

 

We depend on sales of the Hi Art system for substantially all of our revenue and if we are unable to grow or sustain sales of the Hi Art system, we may not generate sufficient revenue to support our business.

 

Our sole product is the Hi Art system, which we commenced marketing in 2003. We expect to generate substantially all of our revenue for the foreseeable future from sales of the Hi Art system and post-warranty service contracts for the Hi Art system. Accordingly, we are dependent on our ability to market and sell the Hi Art system. Any factor materially adversely affecting our ability to market and sell the Hi Art system or pricing and demand for the Hi Art system would have a material adverse effect on our financial condition and results of operations.

 

The long sales cycle and high unit price of the Hi Art system, as well as other factors, may contribute to substantial fluctuations in our quarterly operating results and stock price and make it difficult to compare our results of operations to prior periods.

 

The Hi Art system is a major capital equipment item and has a lengthy sales cycle. Generally, the time from initial customer contact to execution of a purchase order can be one year or more. Following execution of a contract, it may take several additional months for a customer to retrofit an existing radiation treatment room, or bunker, to house the Hi Art system and between nine and twelve months if a new bunker must be constructed. Upon delivery of the Hi Art system to the customer’s facility, it typically takes three to four weeks to complete the installation and on-site testing of the system, including the completion of acceptance test procedures with the customer. We recognize revenue from the sale of the Hi Art system upon receipt of a signed acceptance test procedure report from the customer. Because of the high unit price of the Hi Art system and the relatively small number of units installed each quarter, each installation currently represents a significant component of our revenue for a particular quarter. If a small number of customers defer installation of a Hi Art system for even a short period of time, recognition of a significant amount of revenue may be deferred to a subsequent period. For example, the deferral of a number of anticipated installations in the quarter ended September 30, 2005, resulted in revenue of $14.1 million in that quarter compared to $29.6 million in the prior quarter and $21.9 million in the subsequent quarter. Because our operating costs are relatively fixed, our inability to recognize revenue in a particular quarter may adversely affect our profitability in that quarter. As a result, the inability to recognize revenue in a particular quarter may make it difficult to compare our quarterly operating results with prior periods. In addition, while we believe that our backlog of orders provides a better measure at any particular point in time of the long-term performance prospects of our business than our quarterly operating results, investors may attribute significant weight to our quarterly operating results, which may result in substantial fluctuations in our stock price.

 

We face competition from numerous competitors, many of whom have greater resources than we do, which may make it more difficult for us to achieve significant market penetration.

 

The market for radiation therapy equipment is characterized by intense competition and pricing pressure. We consider the competition for the Hi Art system to be existing radiation therapy systems, primarily using C-arm linear accelerators. 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 market leader for many years and has the majority market share for radiation therapy systems worldwide. Most of our competitors are large, well-capitalized companies with significantly greater market share and resources than

we have. As a result, these companies may be better positioned than we are to spend more aggressively on research and development, marketing, sales and other product initiatives.

 

Our current competitors or other companies may at any time develop new products for the treatment of tumors. If we are unable to develop products that compete effectively against the products of existing or future competitors, our net revenue could decline. 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 these competitors’ pricing techniques are effective, it could result in downward pressure on the price of radiation therapy systems. If we are unable to maintain or increase our selling prices in the face of competition, we may not improve our gross margins.

 

In addition to the competition that we face from technologies performing similar functions to the Hi Art system, competition also exists for the limited capital expenditure budgets of our customers. A potential purchaser may be forced to choose between two items of capital equipment. Our ability to compete may also be adversely affected when purchase decisions are based largely upon price, since the Hi Art system is a premium priced system due to its greater functionality compared to traditional systems. If we are unable to market the Hi Art system more effectively than competing products, which could be purchased as an alternative to the Hi Art system using the same budget at comparable or lower prices, we may be unable to maintain our current growth rate.

 

Our reliance on single-source suppliers for critical components of the Hi Art system could harm our ability to meet demand for our products in a timely and cost effective manner.

 

We currently depend on single-source suppliers for a number of critical components necessary for the assembly of the Hi Art system, including the ring gantry, the linear accelerator, the couch, the solid state modulator, the rotary union, the radiation detector and the magnetron. We purchase some of these components from major industry suppliers. We do not have long-term supply contracts with the suppliers of the solid state modulator, the rotary union and the magnetron. An affiliate of one of our competitors, Siemens Medical Solutions, Inc., is also our supplier for the linear accelerator used in the Hi Art system. If the supply of any of these components were to be disrupted or terminated, or if these suppliers were unable to supply the quantities of components that we require, we may have difficulty or be unable to find alternative sources for these key components. As a result, we may be unable to meet the demand for the Hi Art system, which could harm our ability to generate revenue and damage our reputation. In addition, such a delay in components might cause us to have insufficient spare parts to service existing installed systems, which may lead to customer dissatisfaction. Some of our single-source suppliers have at times had material difficulties maintaining an adequate supply of parts to meet our manufacturing and service demands.

 

We believe it will be necessary to find alternative manufacturers for key components of the Hi Art system over time as our quantity and quality demands evolve, but we may experience a significant delay in locating an alternative manufacturer. Furthermore, we will need to verify that any new manufacturer meets our technical specifications and maintains facilities, procedures and operations that comply with our quality requirements. We will also have to assess any new manufacturer’s compliance with all applicable regulations and guidelines, which could further impede our ability to manufacture our products in a timely manner. If the change in manufacturer results in a significant change to the product, a new 510(k) clearance from the U.S. Food and Drug Administration, or FDA, or similar foreign clearance may be necessary, which would likely cause substantial delays. The occurrence of any of these events could harm our ability to meet the demand for the Hi Art system in a timely manner or within budget.

 

Sales of the Hi Art system may be adversely affected if clinicians do not widely adopt IGRT and adaptive radiotherapy, which is an emerging cancer treatment technique.

 

Our success in marketing the Hi Art system depends in part on persuading clinicians and patients of the benefits of adaptive radiation therapy. Image guided radiation therapy, or IGRT, is an emerging cancer treatment technique which involves delivering intensity modulated radiation therapy, or IMRT, guided by images of the treatment area taken shortly before treatment, using CT, x-ray, ultrasound or other imaging technologies. IMRT is a widely accepted technique, which involves varying, or modulating, the intensity of the radiation beam across a targeted treatment area. Adaptive radiation therapy involves adjusting a patient’s radiation therapy plan between treatment sessions to account for changes in the patient’s anatomy, the amount

and location of the radiation received by the patient, and the size, shape and location of the tumor. In particular, we believe that adaptive radiation therapy requires, and we have designed the Hi Art system to enable, continual adjustments to a patient’s treatment plan throughout the entire course of treatment, facilitated by both the regular acquisition of updated quantitative images showing the location, geometry and density of the tumor, as well as the verification of the actual radiation dose received by the patient. Since IGRT and adaptive radiation therapy are still in the early stages of emergence and implementation, increased sales of the Hi Art system depend, in part, on widespread adoption of these techniques by clinicians. Widespread adoption of IGRT and adaptive radiation therapy depends on many factors, including some that are outside of our control. These factors include acceptance by clinicians that IGRT and adaptive radiation therapy are clinically effective and cost effective in treating a wide range of tumors, demand by patients for such treatment, successful education of clinicians on the various aspects of these techniques and adequate reimbursement for procedures performed using adaptive radiation therapy. If widespread market acceptance of IGRT and adaptive radiation therapy do not occur, or do not occur as rapidly as we anticipate, sales of the Hi Art system may be adversely affected and our revenue may decline or fail to grow at its current rate.

 

We may be delayed or prevented from implementing our long-term sales strategy if we fail to educate clinicians and patients about the benefits of the Hi Art system and to implement enhancements to the system in a timely manner.

 

As of December 31, 2006, we had an installed base of 108 Hi Art systems worldwide. We believe that sales of the Hi Art system to date have been principally to those hospitals and cancer treatment centers that are most open to the adoption of new technologies. In order to expand our sales, we must raise awareness of the range of benefits that we believe the Hi Art system offers to both existing and potential customers, and their patients. An important part of our sales strategy involves educating and training clinicians to utilize the entire functionality of the Hi Art system. In particular, most clinicians are currently unfamiliar with techniques which involve using the full quantitative imaging capabilities of the Hi Art system, which enables clinicians to adapt a patient’s treatment plan in response to anatomical changes and the cumulative amount of radiation received by specific areas within the patient over the course of treatment. In addition, we must further educate clinicians about the ability of the Hi Art system to treat a wide range of cancers effectively and efficiently. If clinicians are not properly educated about the use of the Hi Art system for adaptive radiation therapy, they may be unwilling or unable to take advantage of the full range of functionality that we believe the Hi Art system offers, which could have an adverse effect on our product sales.

 

In determining whether to purchase a single Hi Art system or whether to purchase multiple Hi Art systems, we understand that clinicians may weigh the benefits that the Hi Art system offers their patients, especially those with tumors typically treated using less sophisticated equipment, against the additional time required to implement Hi Art system’s image guided treatment functionality and the higher cost of the Hi Art system when compared to systems with less functionality. Customers or potential customers may decide that certain tumors can be adequately treated using traditional radiation therapy systems, notwithstanding the greater precision and functionality enabled by the Hi Art system. These considerations may be particularly relevant to cancer treatment centers that only have space for a single radiation therapy system. In order to increase sales of the Hi Art system to these customers, we must succeed in implementing enhancements to the Hi Art system to improve speed and patient throughput in order to render the time differentials between certain procedures performed using the Hi Art system and those performed using competitive systems insignificant. We must also succeed in educating clinicians about the potential for cost effective reimbursement for procedures performed using the Hi Art system. In addition, we must raise awareness of the Hi Art system among potential patients, who are increasingly educated about cancer treatment options and therefore drive adoption of new technologies by clinicians. Our efforts to expand sales of the Hi Art system in the long-term may be adversely affected if we fail in implementing these strategies.

 

Our ability to increase our profitability depends in part on reducing our cost of revenue, which we may not be able to achieve.

 

Our gross margin was 38.2% in 2004, 33.9% in 2005 and 34.2% in 2006. Our gross margins have been impacted by higher component costs and failure rates than we originally anticipated, resulting in increased warranty expense and negative profit margins on most of our existing service contracts for the Hi Art

system. We are making investments in developing alternate components, implementing enhancements to increase the performance of components currently used in the Hi Art system and seeking to identify lower priced components of comparable or improved performance and quality. If we are unable to reduce our expenses through these initiatives and maintain competitive pricing of service contracts, our profitability may not improve or may be adversely affected.

 

If we are unable to maintain existing research collaboration relationships, enter into new collaboration arrangements in the future or enter into license agreements with our collaborators and others, our ability to enhance the Hi Art system may be adversely affected.

 

To date, we have entered into research collaboration arrangements with over 20 hospitals, cancer treatment centers and academic institutions, and a national laboratory. These research collaborations support our internal research and development capabilities and represent a key element of our on-going research and development program. Among other things, our current collaborations supplement initiatives to more fully automate the treatment and adaptive therapy processes enabled by the Hi Art system, as well as initiatives to accommodate real-time patient movements during treatment. Our research collaboration partners may not fulfill all of their obligations under our arrangements with them. If our current research collaborations do not meet our research and development expectations, or if we are unable to enter into additional research collaborations in the future to replace unproductive collaborations or add new collaborations, our ability to enhance the Hi Art system may be adversely affected. In addition, we may also face significant competition in seeking third-party collaborators and may be unable to find third parties with whom to pursue research collaborations on a timely basis or on acceptable terms. Our inability to successfully collaborate with third parties would increase our development costs, delay new or pending developments and could limit the likelihood of successful enhancements to the Hi Art system.

 

Our collaboration agreements generally provide that we either (1) own, in the case of our own developments, (2) have the right to use, in the case of joint developments, or (3) have the right to license, in the case of developments by our collaborator, technology developed pursuant to a collaboration. We cannot provide any assurance that we will successfully enter into license agreements with any of our collaborators concerning technology that is jointly developed or developed by the collaborator. If we are unable to enter into exclusive license agreements with a collaborator over technology that is jointly developed with, or solely developed by, the collaborator, the collaborator may be able to use or license the technology to third parties. Furthermore, if we are unable to enter into license agreements with a collaborator for technology that is jointly developed with, or solely developed by, the collaborator, we may be unable to use that technology. In addition, if we are unable to agree with our collaborators concerning ownership or proper inventorship of technology developed under the collaboration agreement, we may be forced to engage in arbitration or litigation to determine the proper ownership or inventorship.

 

We continue to invest in developing technology that we may wish to incorporate into future Hi Art systems in order to improve our product offering and keep pace with our competition. We may need to license such technology from third parties, but there can be no assurance that such licenses will be available on terms acceptable to us or at all.

 

We rely on a third party to perform spare parts shipping and other logistics functions on our behalf. A failure or disruption at our logistics providers would adversely impact our business.

 

Customer service is a critical element of our sales strategy. In particular, Kuehne + Nagel Inc. stores almost all of our spare parts inventory in depots around the world and performs a significant portion of our spare parts logistics and shipping activities. We may utilize additional logistics service providers in connection with the expansion of our international sales. If Kuehne + Nagel suffers an interruption in its business, or experiences delays, disruptions or quality control problems in its operations, or we have to change and qualify an alternative logistics provider, shipments of spare parts to our customers may be delayed and our reputation and results of operations may be adversely affected.

 

If third-party payors do not continue to provide sufficient coverage and reimbursement to healthcare providers for use of the Hi Art system, sales of the Hi Art system may be adversely affected.

 

Our ability to market and sell the Hi Art system successfully depends in part on the extent to which sufficient reimbursement for treatment procedures using the Hi Art system will be available from third-party payors such as private health insurance plans and health maintenance organizations and, to a lesser degree, government payor programs such as Medicare and Medicaid. Third-party payors, and in particular managed care organizations, are continuously challenging the prices charged for medical products and services and instituting cost containment measures to control or significantly influence the purchase of medical products and services. These cost containment measures, if instituted in a manner affecting the coverage of, or reimbursement for, treatment procedures performed using the Hi Art system, could discourage cancer treatment centers and hospitals from purchasing the Hi Art system.

 

Treatment procedures performed using the Hi Art system are currently covered and reimbursed at acceptable rates by third-party payors. However, we cannot provide any assurance that third-party payors will continue to reimburse these procedures at current rates or will continue to consider these procedures to be cost-effective compared to other treatments. Clinicians may be reluctant to purchase the Hi Art system 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 using the Hi Art system, which could have an adverse impact on our sales.

 

Reimbursement for services rendered to Medicaid beneficiaries is determined pursuant to each state’s Medicaid plan, which is established by state law and regulations and is subject to the requirements of federal laws and regulations. The Balanced Budget Act of 1997 revised the Medicaid program to provide each state more control over coverage and payment matters. In addition, the Centers for Medicare and Medicaid Services has granted many states waivers to allow for greater control of the Medicaid program at the state level. The impact on our business of this greater state control on Medicaid payment for diagnostic services remains uncertain.

 

Our success in non-U.S. markets also depends upon treatment procedures using the Hi Art system 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 product and these efforts are expected to continue. Market acceptance of the Hi Art system 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 the Hi Art system in markets outside of the United States in which we are selling, or are seeking to sell, the Hi Art system.

 

We have a limited history of manufacturing the Hi Art system in commercial quantities and may encounter manufacturing problems or delays that could result in lost revenue.

 

We commenced manufacturing the Hi Art system in late 2002 and recently moved production to a newly-constructed facility in Madison, Wisconsin. The manufacturing processes at our facility include subassembly, assembly, system integration and testing. We must manufacture and assemble the Hi Art system in commercial quantities in compliance with regulatory requirements and at an acceptable cost. We have only a limited history of manufacturing commercial quantities of the Hi Art system and, as a result, we may have difficulty manufacturing the Hi Art system in sufficient quantities in a timely manner. To manage our manufacturing operations with our suppliers, we forecast anticipated product orders and material requirements to predict our inventory needs up to six months in advance and enter into purchase orders on the basis of these requirements. Our limited manufacturing history may not provide us with enough data to accurately predict future component demand. Accordingly, we may encounter difficulties in scaling up production of the Hi Art system, including problems with quality control and assurance, component supply shortages, increased costs, shortages of qualified personnel and difficulties associated with compliance with local, state, federal and foreign regulatory requirements. In addition, if we are unable to maintain larger-scale manufacturing capabilities, our ability to generate revenue will also be limited and our reputation could be damaged. If we

cannot achieve the required level and quality of production, we may need to outsource production or rely on licensing and other arrangements with third parties who possess sufficient manufacturing facilities and capabilities in compliance with regulatory requirements. Even if we could outsource needed production or enter into licensing or other third-party arrangements, this could reduce our gross margin.

 

Our manufacturing operations are conducted at a single location and any disruption at our facility could increase our expenses.

 

All of our manufacturing operations are conducted at a single location in Madison, Wisconsin. This location contains bunkers for testing the Hi Art system because it emits radiation. We do not maintain a backup manufacturing facility and we therefore depend on our current facility for the continued operation of our business. We take precautions to safeguard our facility, including insurance, health and safety protocols, and off-site storage of computer data. However, a natural disaster could cause substantial delays in our manufacturing operations, damage or destroy our manufacturing equipment or inventory, and cause us to incur additional expenses. The insurance we maintain against natural disasters may not be adequate to cover our losses in any particular case. With or without insurance, damage to our manufacturing facility or our other property, or to any of our suppliers, due to a natural disaster or casualty event may have a material adverse effect on our business, financial condition and results of operations.

 

We rely on local distributors to market and distribute the Hi Art system in much of the Asian market.

 

We rely on third-party distributors for the marketing and distribution of the Hi Art system in Japan, Taiwan, South Korea, Singapore, India and China. The percentage of our revenue derived from sales by local distributors was 11% in 2005 and 21% in 2006. A component of our growth strategy is to expand our marketing and sales through distributors in additional countries. In our standard distribution agreement, we appoint an exclusive distributor for a specific country for a period of three years. The agreement sets forth annual sales targets and we are entitled to terminate the agreement if the distributor fails to meet these sales targets. To date, we have not had to terminate our relationship with a single distributor due to a failure to meet the minimum sales targets. We have also developed a certification procedure to ensure each distributor can fulfill its obligations under the distribution agreement. Accordingly, our success in generating sales in countries where we have engaged local distributors depends in part on the efforts of others whom we do not control. Many of our local distributors have only limited personnel capabilities, although we require them to assume responsibility for marketing, sales and service efforts in their country. As a result, these distributors may not be able to successfully market, sell and service the Hi Art system, may not devote sufficient time and resources to support adequate marketing and selling efforts, and may not market the Hi Art system at prices that will permit the Hi Art system to develop, achieve or sustain market acceptance, any of which could adversely affect our potential for revenue from international markets. In addition, if a distributor is terminated by us or goes out of business, it may take us a period of time to locate an alternative distributor and to train its personnel to market the Hi Art system and our ability to sell the Hi Art system in that distributor’s country could be adversely affected.

 

Our results may be adversely affected by changes in foreign currency exchange rates.

 

In 2006, we derived 84% of our revenue from contracts denominated in U.S. dollars, 15% in Euros and 1% in Canadian dollars. The substantial majority of our expenses have historically been denominated in U.S. dollars. However, in 2006 we opened an office in Brussels, Belgium and increased our hiring efforts in Europe. As a result, we anticipate that an increasing portion of our expenses will be denominated in Euros. If the U.S. dollar weakens against the Euro, it will have a negative impact on our profit margins. We do not currently have a hedging program in place to offset these risks.

 

In addition, long-term movements in foreign currency exchange rates could affect the competitiveness of the Hi Art system. In the recent past, we have benefited from a relatively weak U.S. dollar that has made our pricing more competitive compared to our non-U.S. competitors. This has been a contributor to our international orders and revenue growth. Although sales of the Hi Art system internationally may occur in local currencies, our overall cost structure remains largely U.S. dollar based. If some of our competitors have cost structures based in other currencies, our overall margins and pricing competitiveness may be adversely affected. Any significant strengthening of the U.S. dollar against other countries’ currencies may result in

slower growth in our international orders and revenue, which could negatively affect our overall financial performance and results.

 

Technological breakthroughs in cancer treatment could render the Hi Art system obsolete.

 

The cancer treatment market is characterized by continual technological change and product innovation. The Hi Art system is based on our proprietary technology, but a number of our competitors are pursuing new radiation therapy systems incorporating IGRT and adaptive radiation therapy techniques. In addition, companies in the pharmaceutical or biotechnology fields may seek to develop methods of cancer treatment that are more effective than radiation therapy, resulting in decreased demand for the Hi Art system. Because the Hi Art system has a long development cycle and because it can take significant time to receive government approvals for changes to the Hi Art system, we must anticipate changes in the marketplace and the direction of technological innovation. Accordingly, if we are unable to anticipate and address new innovations in the cancer treatment market, the Hi Art system or an aspect of its functionality may be rendered obsolete, which would have a material adverse effect on our business, financial condition and results of operations.

 

A significant percentage of our sales are in international markets, and economic, political and other risks associated with international sales and operations could adversely affect our sales or make them less predictable.

 

The percentage of our revenue derived from sales of the Hi Art system outside of North America was 6% in 2004, 22% in 2005 and 43% in 2006. To accommodate our international sales, we have invested significant financial and management resources to develop an international infrastructure that will meet the needs of our customers. In particular, in 2006 we opened a European office in Brussels, Belgium which includes sales, service and call center operations. In addition, we have entered into agreements with distributors in Asia who purchase the Hi Art system from us for resale to end customers. We support our international marketing and sales activities from both our U.S. headquarters in Madison, Wisconsin and our office in Brussels, Belgium.

 

We face additional risks resulting from our international operations including:

 

 

 

 

If we fail to overcome the challenges we encounter in our international operations, our business will be materially adversely affected.

 

Product liability suits, whether or not meritorious, could be brought against us due to an alleged defective component of the Hi Art system or for the misuse of the Hi Art system. These suits could result in expensive and time-consuming litigation, payment of substantial damages and an increase in our insurance rates.

 

Our business exposes us to potential product liability claims that are inherent in the manufacture, sale, installation, servicing and support of medical devices. The medical device industry has historically been litigious, and we would face financial exposure to product liability claims if the use of the Hi Art system were to cause or contribute to injury or death, whether by aggravating existing patient symptoms or otherwise. Because the Hi Art system involves the delivery of radiation to the human body, the possibility for significant

injury or death exists. The tolerance for error in the design, manufacture, installation, servicing, support or use of the Hi Art system may be small or nonexistent. We may also be subject to claims for property damage or economic loss related to, or resulting from, any errors or defects in the Hi Art system, or the installation, servicing and support of the Hi Art system, or any professional services rendered in conjunction with the Hi Art system. Additionally, it is also possible that defects in the design or manufacture of the Hi Art system might necessitate a product recall. For instance, new components or enhancements to the Hi Art system may contain undetected errors or performance problems that, despite testing, are discovered only after installation. Although we maintain product liability insurance for the Hi Art system, the coverage limits of these policies may be inadequate to cover future claims. As sales of the Hi Art system increase, we may be unable to maintain product liability insurance on acceptable terms or at reasonable costs and such insurance may not provide us with adequate coverage for all potential liabilities. A successful claim brought against us relating to a liability that is in excess of our insurance coverage, or for which insurance coverage is denied or limited, would require us to pay damage amounts that could be substantial and have a material adverse effect on our financial position and could divert management’s attention from our core business.

 

The effectiveness of procedures performed using the Hi Art system are not yet supported by long-term clinical data and the medical community has not yet developed a large body of peer-reviewed literature that supports the Hi Art system’s safety and efficacy.

 

We do not have significant clinical data supporting the advantages that we believe the Hi Art system offers in comparison with competing products and technologies. For example, because the Hi Art system has only been on the market since 2003, we have only limited complication or patient survival rate data, which are a common long-term measures of clinical effectiveness in cancer treatment. In addition, there are a limited number of peer-reviewed medical journal publications regarding the safety and efficacy of the Hi Art system. If future patient studies or clinical experience do not support our beliefs that the Hi Art system offers a safe and effective treatment for a wide variety of cancers, use of the Hi Art system could fail to increase or could decrease, and our growth and operating results would therefore be adversely affected. In addition, if future results and experience indicate that the Hi Art system causes unexpected or serious complications or other unforeseen negative effects, the FDA could rescind our clearances, our reputation with clinicians and patients could suffer and we could be subject to significant legal liability.

 

Our success will depend on our ability to attract and retain qualified personnel.

 

We are highly dependent on members of our senior management, operations and research and development staff. Our continued success will depend on our ability to retain our current management and qualified personnel with expertise in research and development, engineering, service, manufacturing, sales, marketing and finance. Competition is intense in the medical device industry for senior management personnel, as well as other qualified personnel, and finding and retaining such personnel with experience in our industry is very difficult. There is substantial time and training required for all newly-hired employees to learn our product and proprietary systems. The loss of the services of certain members of our senior management, scientists, clinicians, or engineers could prevent the implementation and completion of our business objectives. The loss of a member of senior management or our professional staff would also require the remaining executive officers to divert substantial attention to seeking a replacement.

 

Additionally, the sale and after-sale support of the Hi Art system is logistically complex, requiring us to maintain an extensive infrastructure of field sales and customer support personnel. We face considerable challenges, including managing geographically dispersed efforts, in recruiting, training, managing, motivating and retaining these teams. If we are unable to maintain and grow an adequate pool of trained and motivated personnel, our reputation could suffer and our financial position could be adversely affected.

 

If we do not effectively manage our growth, our business may be significantly harmed.

 

The number of our employees increased from 327 as of December 31, 2005 to 492 as of December 31, 2006. In addition, we have significantly expanded our activities outside of the United States, including the establishment of a customer support center in Brussels, Belgium and spare parts depots around the world. In order to implement our business strategy, we expect continued growth in our employee and infrastructure requirements, particularly as we expand our manufacturing, customer service and sales and marketing capacities.

To manage our growth, we must expand our facilities, augment our management, operational and financial systems, hire and train additional qualified personnel, scale-up our manufacturing capacity and expand our marketing and distribution capabilities. Our manufacturing, assembly and installation process is complex and we must effectively scale this entire process to satisfy customer expectations and changes in demand. We also expect to increase the number of sales and marketing personnel as we expand our business, and although the number of people we employ in our international offices has grown significantly, in many international locations we still lack the minimum critical mass to qualify for group efficiencies, which drives our overall cost of operations higher. We cannot be certain that our personnel, systems, procedures and internal controls will be adequate to support our future operations. Our business will suffer if we cannot manage our growth effectively.

 

Many countries require that software user interfaces be translated into their respective local language. Failure to adhere to each country’s law with respect to the language of the user interface may cause substantial disruptions in the delivery of new systems and the use of existing systems.

 

The governmental agencies regulating medical devices in some countries require that the user interface on medical device software be in the local language. This may conflict with the preferences of some end customers who believe that an English user interface allows for the broadest range of use by clinicians and the safest way to utilize the system. We currently provide user guides and manuals in the local language but only provide an English language version of the user interface. If we cannot convert our user interface to local languages to comply with those regulatory requirements, the use of our systems may be interrupted and it may cause the delay or cessation of future sales in those countries.

 

We may need to raise additional capital in the future and may be unable to do so on acceptable terms. This could limit our ability to grow and carry out our business plan.

 

We believe that the net proceeds from this offering, together with our cash reserves and cash from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. If our estimates of revenue, expenses, or capital or liquidity requirements change or are inaccurate, or if cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or arrange additional debt financing. In the future, we may also seek to sell additional equity or arrange debt financing to give us financial flexibility to pursue attractive acquisition or investment opportunities that may arise, although we currently do not have any acquisitions or investments planned. We cannot be certain that we will be able to obtain additional financing on commercially reasonable terms or at all, which could limit our ability to grow and carry out our business plan, or that any such additional financing, if raised through the issuance of equity securities, will not be dilutive to our existing shareholders. If we raise additional funds through licensing arrangements, it may be necessary to relinquish potentially valuable rights to our products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. If any of these events occurs, it could adversely affect our business, financial condition and results of operations.

 

We have not yet evaluated our internal controls over financial reporting in compliance with Section 404 of the Sarbanes-Oxley Act.

 

Upon the effectiveness of this registration, we will be required to comply with the internal control evaluation and certification requirements of Section 404 of the Sarbanes-Oxley Act by no later than the end of our 2008 fiscal year. We are in the process of determining whether our existing internal controls over financial reporting systems are compliant with Section 404. This process may divert internal resources and will take a significant amount of time and effort to complete. To the extent that we are not currently in compliance with Section 404, we may be required to implement new internal control procedures and re-evaluate our financial reporting. We may experience higher than anticipated operating expenses as well as increased independent auditor fees during the implementation of these changes and thereafter. Further, we may need to hire additional qualified personnel in order for us to comply with Section 404. If we are unable to implement these changes effectively or efficiently, it could harm our operations, financial reporting or financial results and could result in our being unable to obtain an unqualified report on internal controls from our independent auditors, which could have a negative impact on our stock price.

Risks Related to Our Intellectual Property

 

If we are not able to meet the requirements of our license agreement with the Wisconsin Alumni Research Foundation, or WARF, we could lose access to the technologies licensed thereunder and be unable to produce or sell the Hi Art system.

 

We license from WARF significant technology under a license agreement that requires us to pay royalties to WARF. In addition, the license agreement obligates us to pursue an agreed development plan and to submit periodic reports, and restricts our ability to take actions to defend the licensed patents. WARF has the right to unilaterally terminate the agreement if we do not meet certain minimum royalty obligations or satisfy other obligations related to our utilization of the technology. If WARF were to terminate the agreement or if we were to otherwise lose the ability to exploit the licensed patents, our competitive advantage would be greatly reduced and we may not be able to find a source to replace the licensed technology.

 

The license agreement reserves to WARF the right to defend or prosecute any claim arising with respect to the licensed technology. If WARF does not vigorously defend the patents, any competitive advantage we have based on the licensed technology may be hampered. WARF also has the option, without receiving our prior consent, to settle a claim by granting a license to a third party for any of the licensed technology. Such a license would have the potential to reduce our competitive advantage.

 

If we are not able to adequately protect our intellectual property and proprietary technology our competitive position, future business prospects and financial performance will be adversely affected.

 

Our success depends significantly on our ability to protect our intellectual property and proprietary technologies used in the Hi Art system. If we fail to obtain patents, are unable to obtain patents with claims of a scope necessary to cover our technology, or our issued patents are determined to be invalid or not to cover our technology, our competitors could use portions of our intellectual property, which could weaken our competitive position. We have an active program to protect our proprietary inventions through the filing of patent applications and taking certain steps to preserve the confidentiality of our confidential and proprietary information. There can be no assurance, however, that:

 

 

Although we have attempted to obtain patent coverage for our technology where available and appropriate, there are aspects of the technology for which patent coverage was never sought or never received. There are also countries in which we sell or intend to sell the Hi Art system, but have no patents or pending patent applications. Our ability to prevent others from making or selling duplicate or similar technologies will be impaired in those countries in which we have no patent protection. We also may not be able to protect our patent rights effectively in some foreign countries.

 

Our failure to protect the intellectual property we create would cause our business to suffer.

 

In addition to patents, we rely on a combination of copyright, trade secret and other laws, and contractual restrictions on disclosure, copying and transferring title, including confidentiality agreements with vendors, strategic partners, co-developers, employees, consultants and other third parties, to protect our proprietary rights. We cannot be certain that these contracts have not and will not be breached, that we will have adequate remedies for any breach or that our trade secrets will not otherwise become known or be independently developed by competitors. We cannot be certain that the steps we have taken to protect our proprietary information will be sufficient to safeguard the technology underlying the Hi Art system.

 

We may initiate lawsuits to protect or enforce our patents or other intellectual property rights, which could be expensive and, if we lose, could cause us to lose some of our intellectual property rights.

 

There may be companies that are currently marketing or may, in the future, market products that compete with the Hi Art system in a direct challenge to our intellectual property position. In such cases, we may initiate litigation in order to stop them. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially valuable. Even if successful, litigation to enforce our intellectual property rights or to defend our patents against challenge could be expensive and time consuming and could divert our management’s attention from our core business. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, we may provoke third parties to assert claims against us.

 

In addition, we may become involved in litigation to protect our trademark rights associated with our company name or the names used with the Hi Art system. Third parties may assert that our company name and names used with the Hi Art system infringe rights held by others or are ineligible for proprietary protection. If we have to change the name of our company or the Hi Art system, we may experience a loss in goodwill associated with our brand name, customer confusion and a loss of sales.

 

We may become subject to costly intellectual property litigation, which could affect our future business and financial performance.

 

The medical device industry has been characterized by frequent intellectual property litigation. In particular, the field of radiation therapy for cancer is well-established and crowded with the intellectual property of competitors and others. A number of companies in our market, as well as universities and research institutions, have intellectual property, including patents and patent applications, that relate to the use of radiation therapy to treat cancer. We have not conducted an extensive search of patents pending or issued to third parties, and no assurance can be given that third party patents containing claims covering the Hi Art system, technology or methods do not exist, have not been filed or could not be filed or issued. Because of the number of patents issued and patent applications filed in our technical areas or fields, our competitors or other third parties may assert that the Hi Art system and the methods we employ in the use of our product are covered by United States or foreign patents held by them. As the number of competitors in the market for less invasive cancer treatment alternatives grows, and as the number of patents issued in this area grows, the possibility of patent infringement claims against us increases. Any such claim or litigation, regardless of merit, could cause us to incur substantial expenses and delay or materially disrupt the conduct of our business. We could also be required to pay a substantial damage award, develop non-infringing technology, enter into royalty-bearing licensing agreements, if such licenses are available on terms reasonable to us or at all, or stop selling our products. Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise the funds necessary to continue our operations.

 

We may be subject to claims that our employees have wrongfully used or disclosed alleged trade secrets of their former employers.

 

As is common in the medical device industry, we employ individuals who were previously employed at other medical equipment or biotechnology companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

Risks Related to Regulatory Matters

 

Modifications, upgrades and future products related to the Hi Art system or new indications may require new FDA premarket approvals or 510(k) clearances, and such modifications, or any defects in design or manufacture may require us to recall or cease marketing the Hi Art system until approvals or clearances are obtained.

 

The Hi Art system is a medical device that is 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 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 usually takes 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. Despite the time, effort and cost, there can be no assurance that any particular device will be approved or cleared by the FDA through either the premarket approval process or 510(k) clearance process. We have obtained 510(k) clearance from the FDA to market the Hi Art system for the treatment of tumors or other targeted tissues anywhere in the body where radiation therapy is indicated. An element of our strategy is to continue to upgrade the Hi Art system to incorporate new software and hardware enhancements that may require the approval of or clearance from the FDA or its foreign counterparts. Certain upgrades previously released by us required 510(k) clearance before we were able to offer them for sale. We expect that certain of our future upgrades to the Hi Art system will also require 510(k) clearance; however, future upgrades may be subject to the substantially more time-consuming and uncertain premarket approval process.

 

The FDA requires device manufacturers to determine whether or not a modification requires an approval or clearance. 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. We have made modifications to the Hi Art system in the past and may make additional modifications in the future that we believe do not or will not require additional approvals or clearances. If the FDA disagrees and requires us to obtain additional premarket approvals or 510(k) clearances for any modifications to the Hi Art system and we fail to obtain such approvals or clearances or fail to secure approvals or clearances in a timely manner, we may be required to cease manufacturing and marketing the modified device or to recall modified devices until we obtain FDA approval or clearance. In addition, we may be subject to significant regulatory fines or penalties.

 

The FDA and its foreign counterparts regulate virtually all aspects of a medical device’s design, development, testing, manufacturing, labeling, storage, record keeping, reporting, sale, promotion, distribution and shipping. Medical devices may be marketed only for those indications for which they are approved or cleared. The FDA and its foreign counterparts also 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 device, or could impact our ability to market our currently cleared device.

 

The Hi Art system is subject to recalls even after receiving FDA clearance or approval, which would harm our reputation, business and financial results.

 

We are subject to the medical device reporting regulations, which require us to report to the FDA if the Hi Art system causes or contributes to a death or serious injury, or malfunctions in a way that would likely cause or contribute to a death or serious injury. The FDA and similar governmental bodies in other countries have the authority to require the recall of the Hi Art system if we fail to comply with relevant regulations pertaining to manufacturing practices, labeling, advertising or promotional activities, or if new information is obtained concerning the safety or efficacy of the Hi Art system. A government-mandated or voluntary recall by us could occur as a result of manufacturing defects, labeling deficiencies, packaging defects or other failures to comply with applicable regulations. Any recall would divert management attention and financial resources and could harm our reputation with customers. A recall involving the Hi Art system could be particularly harmful to our business, financial condition and results of operations because it is currently our only product.

 

If we or our distributors do not obtain and maintain the necessary regulatory approvals in a specific country, we will not be able to market and sell the Hi Art system in that country.

 

To be able to market and sell the Hi Art system in a specific country, we or our distributors must comply with the regulations of that country. While the regulations of some countries do not impose barriers to marketing and selling the Hi Art system or only require notification, others require that we or our distributors obtain the approval of a specified regulatory body. These regulations, including the requirements for approvals, and the time required for regulatory review vary from country to country. Obtaining regulatory approvals is expensive and time-consuming, and we cannot be certain that we or our distributors will receive regulatory approvals in each country in which we plan to market the Hi Art system. If we modify the Hi Art system, we or our distributors may need to apply for additional regulatory approvals before we are permitted to sell it. We may not continue to meet the quality and safety standards required to maintain the authorizations that we or our distributors have received. If we or our distributors are unable to maintain our authorizations in a particular country, we will no longer be able to sell the Hi Art system in that country, and our ability to generate revenue will be materially adversely affected.

 

We must manufacture the Hi Art system in accordance with federal and state regulations and we could be forced to recall our installed systems or terminate production if we fail to comply with these regulations.

 

We are required to comply with the FDA’s quality system regulations, which is a complex regulatory scheme that covers the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of the Hi Art system. Furthermore, we are required to verify that our suppliers maintain facilities, procedures and operations that comply with our quality requirements. The FDA enforces the Quality System Regulation through periodic inspections. Our quality system has passed several third-party audits, but has not yet been inspected by the FDA. The Hi Art system is also subject to similar state regulations and various worldwide laws and regulations. If in the future we fail a Quality System Regulation inspection, our operations could be disrupted and our manufacturing operations delayed. Failure to take adequate corrective action in response to a Quality System Regulation inspection could force a shutdown of our manufacturing operations and a recall of the Hi Art system. If any of these events occurs, our reputation could be harmed, and we could lose customers and suffer reduced revenue and increased costs.

 

If we are found to have violated laws protecting the confidentiality of patient health information, we could be subject to civil or criminal penalties, which could increase our liabilities and harm our reputation or our business.

 

There are a number of federal and state laws protecting the confidentiality of certain patient health information, including patient records, and restricting the use and disclosure of that protected information. In particular, the U.S. Department of Health and Human Services has promulgated patient privacy rules under the Health Insurance Portability and Accountability Act of 1996, or HIPAA. These privacy rules protect medical records and other personal health information by limiting their use and disclosure, giving individuals the right to access, amend and seek accounting of their own health information and limiting most uses and disclosures of health information to the minimum amount reasonably necessary to accomplish the intended purpose. Although we are not a covered entity under HIPAA, we have entered into agreements with certain covered entities under which we are considered to be a “business associate” under HIPAA. As a business associate, we are required to implement policies, procedures and reasonable and appropriate security measures to protect individually identifiable health information we receive from covered entities. Our failure to protect health information received from customers could subject us to liability and adverse publicity, and could harm our business and impair our ability to attract new customers.

 

In addition, if the firewall software protecting the information contained in the Hi Art system’s database fails or someone is successful in hacking into the database, we could face damage to our business reputation and possible litigation and regulatory action. Certain governmental agencies, such as the U.S. Department of Health and Human Services and the Federal Trade Commission, have the authority to protect against the misuse of consumer information by targeting companies that collect, disseminate or maintain personal information in an unfair or deceptive manner. We are also subject to the laws of those foreign jurisdictions in which we sell the Hi Art system,

some of which currently have more protective privacy laws. If we fail to comply with applicable regulations in this area, our business and prospects could be harmed.

 

We are subject to federal and state laws prohibiting “kickbacks” and false or fraudulent claims, which, if violated, could subject us to substantial penalties. Additionally, any challenge to or investigation into our practices under these laws could cause adverse publicity and be costly to respond to, and thus could harm our business.

 

A federal law commonly referred to as the Medicare/Medicaid anti-kickback law, and several similar state laws, prohibit persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs, such as Medicare and Medicaid.

 

These laws constrain our sales, marketing and other promotional activities by limiting the kinds of financial arrangements, including sales programs, we may have with hospitals, physicians or other potential purchasers of medical devices. We have a variety of arrangements with our customers that could implicate these laws. For example, we provide research grants to some of our customers to support customer studies related to protocols in using the Hi Art system. Due to the breadth of some of these laws, and the range of interpretations to which they are subject to, it is possible that some of our current or future practices might be challenged under one or more of these laws. Other federal and state laws generally prohibit individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid or other third-party payors that are false or fraudulent, or for items or services that were not provided as claimed. While we do not give our customers advice on coding or billing procedures performed using the Hi Art system, we may inadvertently or informally provide billing or code information in response to customer inquiries regarding reimbursement for procedures. We cannot provide any assurance that the government will not view our inadvertent or informal statements regarding billing or coding to be advice, in which case we could be liable for providing erroneous advice. Anti-kickback and false claims laws prescribe civil and criminal penalties for noncompliance, which can be substantial. Even an unsuccessful challenge or investigation into our practices could cause adverse publicity, and be costly to respond to, and thus could have a material adverse effect on our business, financial condition and results of operations.

 

Risks Related to Our Common Stock and This Offering

 

Our common stock has not been publicly traded and we expect that the price of our common stock will fluctuate substantially.

 

Prior to this offering, there has been no public market for shares of our common stock. An active public trading market may not develop following completion of this offering or, if developed, may not be sustained. The price of the shares of common stock sold in this offering will be determined by negotiation between the underwriters and us. This price will not necessarily reflect the market price of our common stock following this offering. The market price of our common stock following this offering will be affected by a number of factors, including:

 

 

 

 

Share price fluctuations may be exaggerated if the trading volume of our common stock is too low. The lack of a trading market may result in the loss of research coverage by securities analysts. Moreover, we cannot

provide any assurance that any securities analysts will initiate or maintain research coverage of our company and our ordinary shares. If our future quarterly operating results are below the expectations of securities analysts or investors, the price of our common stock would likely decline. Securities class action litigation has often been brought against companies following periods of volatility. Any securities litigation claims brought against us could result in substantial expense and divert management’s attention from our business.

 

Sales of a substantial number of shares of our common stock in the market by our existing shareholders, or the perception that such sales could occur, could result in a decline in our stock price.

 

Upon completion of this offering, we will have 48,345,337 shares outstanding. The 10,937,500 shares of our common stock we and the selling shareholders are selling in this offering will be freely tradable without restriction immediately following this offering. Holders of approximately 99.5% our outstanding shares, including all of our directors and officers, have signed lock-up agreements for a period of 180 days following the date of this prospectus, subject to extension in the case of an earnings release or material news or a material event relating to us. In addition, the holders of options to purchase 1,450,463 shares, out of a total of vested options to purchase 2,069,862 shares as of March 31, 2007, have signed lock-up agreements. Merrill Lynch, Pierce, Fenner & Smith Incorporated may, in its sole discretion and without notice, release all or any portion of the shares subject to lock-up agreements. As restrictions on resale end, the market price of our common stock could drop significantly if the holders of these restricted shares sell them or are perceived by the market as intending to sell them. These factors could also make it more difficult for us to raise additional funds through future offerings of our shares or other securities. The following chart shows when we expect that the remaining 37,407,837 shares that are not being sold in this offering will be available for resale in the public markets.

 

 

In addition, upon completion of this offering, subject to certain conditions, holders of an aggregate of approximately 24,939,356 shares of common stock will have the right to require us to file registration statements relating to their shares or to include their shares in registration statements that we may file for ourselves or other shareholders with the Securities and Exchange Commission, or SEC. We also intend to register approximately 9,533,677 shares of our common stock that are authorized for issuance under our equity compensation plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to the lock-up agreements described above and the restrictions imposed on our affiliates under Rule 144.

 

Our executive officers, directors and current and principal shareholders own approximately 37.8% of our outstanding common stock and could limit new shareholders’ influence on corporate decisions or could delay or prevent a change in corporate control.

 

Following the closing of this offering, the largest beneficial owners of our shares, Venture Investors, Avalon Technology and Endeavors Group, each of which currently beneficially owns more than 10.0% of our outstanding shares, will beneficially own in the aggregate 32.8% of our shares, or 30.7% if the underwriters exercise their overallotment option. As a result, these shareholders, if acting together, could exercise significant influence over the outcome of all matters submitted to our shareholders for approval. This concentration of ownership could have the effect of:

 

 

 

This concentration of ownership may also adversely affect our share price.

 

You will experience immediate and substantial dilution in the net tangible book value of the shares of our common stock you purchase in this offering.

 

The initial public offering price of our common stock is expected to exceed substantially the net tangible book value per share of our common stock immediately after this offering. Therefore, based on the midpoint of the range set forth on the cover of this prospectus of $16.00 per share, if you purchase our common stock in this offering, you will suffer immediate dilution of $12.13 per share. As a result of this dilution, investors purchasing 10,200,000 shares from us will have contributed 79.2% of the total amount of our total funding to date but will only own 22.2% of our equity. If outstanding options and warrants to purchase our shares are exercised in the future, you will experience additional dilution.

 

We have broad discretion in the use of the net proceeds from this offering and may not obtain a favorable return on the use of these proceeds.

 

We cannot specify with certainty the particular uses of the net proceeds we will receive from this offering. Our management will have broad discretion in the application of the net proceeds, including for any of the purposes described in “Use of Proceeds.” Accordingly, you will have to rely upon the judgment of our management with respect to the use of the net proceeds, with only limited information concerning management’s specific intentions. Our management may spend a portion or all of the net proceeds we receive from this offering in ways that our shareholders may not desire or that may not yield a favorable return. The failure by our management to apply these funds effectively could harm our business. Pending their use, we may invest the net proceeds we receive from this offering in a manner that does not produce income or that loses value.

 

We do not anticipate paying cash dividends on our common stock in the future.

 

We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. The payment of dividends will be at the discretion of our board of directors and will depend on our results of operations, capital requirements, financial condition, prospects, contractual arrangements, any limitations on payments of dividends present in our current and future debt agreements, and other factors our board of directors may deem relevant. We are subject to a covenant under our line of credit agreement that places restrictions on our ability to pay dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of potential gain for the foreseeable future.

 

Anti-takeover provisions included in our amended and restated articles of incorporation and bylaws could delay or prevent a change of control of our company, which could adversely impact the value of our common stock and may prevent or frustrate attempts by our shareholders to replace or remove our current management.

 

Our amended and restated articles of incorporation and amended and restated bylaws, which are to become effective at the closing of this offering, contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our shareholders might consider favorable. These provisions include the following:

 

 

 

 

 

 

In addition, a change of control of our company may be discouraged, delayed or prevented by Sections 180.1140 to 180.1144 of the Wisconsin Business Corporations Law. These provisions generally restrict a broad range of business combinations between a Wisconsin corporation and a shareholder owning 10% or more of our outstanding voting stock. These and other provisions in our amended and restated articles of incorporation, amended and restated bylaws and Wisconsin law could make it more difficult for shareholders or potential acquirors to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors, including to delay or impede a merger, tender offer or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

 

This prospectus contains forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. These statements include, but are not limited to:

 

 

 

 

 

 

 

These statements may be found primarily in the sections of this prospectus entitled “Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and in this prospectus generally, including the section of this prospectus entitled “Business — Overview” and “Business — Market Overview,” which contain information obtained from independent industry sources. Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including all the risks discussed in “Risk Factors” and elsewhere in this prospectus.

 

In addition, statements that use the terms “believe,” “expect,” “plan,” “intend,” “estimate,” “anticipate” and similar expressions are intended to identify forward-looking statements. All forward-looking statements in this prospectus reflect our current views about future events and are based on assumptions and are subject to risks and uncertainties that could cause our actual results to differ materially from future results expressed or implied by the forward-looking statements. Many of these factors are beyond our ability to control or predict. You should not put undue reliance on any forward-looking statements. Unless we are required to do so under U.S. federal securities laws or other applicable laws, we do not intend to update or revise any forward-looking statements.

 

The safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act do not apply to the forward-looking statements that are made in this prospectus.

USE OF PROCEEDS

 

We estimate that we will receive net proceeds of approximately $150.0 million from the sale of common stock offered in this offering, assuming an initial public offering price of $16.00 per share, the midpoint of the price range set forth on the cover of this prospectus, and after deducting the underwriting discount and estimated offering expenses payable by us. Each $1.00 increase or decrease in the assumed public offering price of $16.00 per share would increase or decrease the net proceeds to us from this offering by approximately $9.5 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses payable by us.

 

We intend to use the net proceeds from this offering to finance expanding our selling and marketing efforts, increasing our research and development programs, expanding our international service and support group, and for working capital and other general corporate purposes. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, products or technologies, although we currently do not have any acquisitions or investments planned.

 

We will have broad discretion in the way that we use the net proceeds of this offering. The amounts that we actually spend for the purposes described above may vary significantly and will depend, in part, on the timing and amount of our future revenue.

 

Pending the application of the net proceeds of the offering as described above, we intend to invest the net proceeds of this offering in short-term, interest-bearing, investment-grade securities.

 

We will not receive any of the proceeds from the sale of shares by the selling shareholders.

DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings to finance our research and development efforts, the development of our proprietary technologies and the expansion of our business and do not intend to declare or pay dividends on our common stock in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon a number of factors, including our results of operations, financial condition, future prospects, growth plans, legal and contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant.

 

The following table sets forth our capitalization as of December 31, 2006:

 

 

 

 

You should read this information together with our consolidated financial statements and the related notes, “Use of Proceeds”, “Description of Capital Stock” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

The preceding table excludes as of December 31, 2006:

 

 

 

If you invest in our common stock, your interest will be immediately diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock after this offering. The pro forma net tangible book value of our common stock as of December 31, 2006 was $28.1 million or $0.78 per share of common stock outstanding. Net tangible book value per share represents the amount of all total tangible assets minus our total liabilities, divided by shares of common stock outstanding at that date. Tangible assets represent total assets excluding goodwill and other intangible assets. Net tangible book value dilution per share to new investors represents the difference between the amount per share paid by purchasers of common stock in this offering and the pro forma net tangible book value per share of common stock immediately after completion of this offering.

 

Our pro forma net tangible book value as of December 31, 2006 would have been $28.1 million, or approximately $0.78 per share, after giving effect to:

 

 

 

Our pro forma as adjusted net tangible book value as of December 31, 2006 would have been $178.1 million, or approximately $3.87 per share, after giving effect to the conversion of all of our shares of preferred stock on a one-for-one basis into shares of common stock and the sale by us of 10,200,000 shares in this offering at the assumed initial public offering price of $16.00 per share, the midpoint of the estimated initial public offering price range, and the receipt by us of the estimated net proceeds of $150.0 million, after deducting the underwriting discount and estimated offering expenses payable by us.

 

This represents an immediate increase in pro forma consolidated net tangible book value of $3.09 per share of common stock to existing shareholders and immediate dilution of $12.13 per share of common stock to new investors purchasing shares in this offering. Dilution per share represents the difference between the price per share to be paid by new investors for the shares sold in this offering and the pro forma consolidated net tangible book value per share immediately after this offering. The following table illustrates this per share dilution:

 

 

The following table presents the differences between the total consideration paid to us and the average price per share paid by existing shareholders and by new investors purchasing shares in this offering, before deducting the estimated underwriting discounts and estimated offering expenses payable by us:

 

The preceding table excludes as of December 31, 2006:

 

 

The number of shares of common stock outstanding in the table on the previous page is based on the pro forma number of shares outstanding as of December 31, 2006 and assumes no exercise of the underwriters’ option to purchase additional shares. If the underwriters’ option to purchase additional shares is exercised in full, the number of shares of common stock held by existing stockholders will be reduced to 33,396,074 shares or 72.6% of the total number of shares of common stock to be outstanding after this offering, and the number of shares of common stock held by investors participating in this offering will be increased to 12,578,125 shares or 27.4% of the total number of shares of common stock to be outstanding after this offering.

 

The following table presents, on a pro forma basis as of December 31, 2006, after giving effect to the issuance of 1,288,669 shares of common stock issuable pursuant to the Series A Investment Agreement (see “Transactions with Related Parties, Promoters and Control Persons — Issuance of Contingent Common Stock”), the exercise of all vested stock options and warrants outstanding as of December 31, 2006, the differences between the number of shares of common stock purchased from us, the total consideration and the weighted average price per share paid by existing shareholders and by investors participating in this offering at an assumed initial public offering price of $16.00 per share, before deducting underwriting discounts and commissions and estimated offering expenses:

 

 

The preceding table excludes as of December 31, 2006:

 

 

 

The number of shares of common stock outstanding in the table above is based on the pro forma number of shares outstanding as of December 31, 2006, and assumes no exercise of the underwriters’ option to purchase additional shares. If the underwriters’ option to purchase additional shares is exercised in full, the number of shares of common stock held by existing shareholders will be reduced to 34,684,743 shares or 73.4% of the total number of shares of common stock to be outstanding after this offering, and the number of shares of common stock held by investors participating in this offering will be increased to 12,578,125 shares or 26.6% of the total number of shares of common stock to be outstanding after this offering.

 

You should read the following selected consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2004, 2005 and 2006 and the consolidated balance sheet data as of December 31, 2005 and 2006 are derived from our audited consolidated financial statements included elsewhere in this prospectus, which have been prepared in accordance with generally accepted accounting principles in the United States. The consolidated statements of operations for the years ended December 31, 2002 and 2003 and the consolidated balance sheet data as of December 31, 2002, 2003 and 2004 have been derived from our audited consolidated financial statements which are not included in this prospectus.

 

 

 

 

 

 

 

The following discussion of our consolidated financial condition and results of operations should be read together with our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements based upon current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors. We discuss factors that we believe could cause or contribute to these differences below and elsewhere in this prospectus, including those set forth under “Risk Factors” and “ Information Regarding Forward-looking Statements.”

 

Overview

 

We have developed, manufacture and sell the Hi Art system, one of the most advanced and versatile radiation therapy systems commercially available for the treatment of a wide variety of cancers. The Hi Art system precisely delivers radiation with sub-millimeter accuracy to kill cancer cells while reducing radiation exposure to surrounding healthy tissue, which we believe can lead to improved patient outcomes.

 

We obtained 510(k) clearance from the FDA to market the Hi Art system in January 2002. We installed the first Hi Art system and the first patient was treated in 2003. Since receiving the initial clearance to market the Hi Art system in the United States, we have expanded our regulatory clearances to include Canada (2003), Japan (2004) and the European Union (2005). We have also received marketing clearance in Australia, Singapore, South Korea and Taiwan. During 2003 and 2004, we focused our sales and marketing efforts primarily in North America. Beginning in 2005, we expanded our sales and marketing efforts to include markets in Western Europe and Asia. In April 2006, we opened a European office in Brussels, Belgium, which includes sales, service and call center operations. We also expanded our Asian distributor network, adding distributors in India and China. We now have six distributors in Asia. In July 2006, we expanded our manufacturing operations into a 64,000 square foot facility in Madison, Wisconsin.

 

We market the Hi Art system to hospitals and cancer treatment centers in North America, Europe and Asia and offer, either directly or through distributors, customer support services in each region. The North American, European and Asian markets accounted for 57%, 22% and 21%, respectively, of our revenue for the year ended December 31, 2006. As of December 31, 2006, we had installed 108 systems at customer sites, consisting of 78 in North America, 16 in Asia and 14 in Europe. As of December 31, 2006, we had a total of 49 employees and 13 distributor or agent organizations in our worldwide sales and marketing group.

 

Since commercial introduction of the Hi Art system in 2003, we have experienced rapid revenue growth and have invested significantly in our manufacturing and service and support infrastructure. Our revenue was $75.8 million in 2005 and $156.1 million in 2006. We had net income of $2.9 million in 2004, $0.2 million in 2005 and $12.8 million in 2006. Net income for 2006 included a $7.8 million benefit from deferred income taxes and an expense of $3.1 million reflecting the fair value of outstanding warrants. As of December 31, 2006, we had a backlog of $164 million, the significant majority of which we expect to deliver in 2007. We define backlog as the total contractual value of all firm orders received for the Hi Art system and optional related products. Such orders must be evidenced by a signed quotation or purchase order from the customer, including the required down payment, if any.

 

Financial Operations

 

Revenue

 

Almost all of our revenue is generated from sales of the Hi Art system. We negotiate the actual purchase price with each customer and, historically, the purchase price has varied significantly. Generally, our international pricing has been higher than our domestic pricing.

 

We recognize revenue from sales of the Hi Art system when:

 

 

 

 

 

Our sales price includes a warranty covering replacement components and service for a one-year period. We record a reserve to cost of revenue at the time of revenue recognition for the expected cost of warranty claims based on our historical experience.

 

The balance of our revenue is generated from post-warranty service contracts and options purchased by our end customers. Our post-warranty service contracts may be purchased with one-year or multiple-year terms, giving our customers the option to contract for the level of equipment support they require. Currently, our most popular service plan is our Total TLC Service Package, or Total TLC, which is a comprehensive care package providing complete system coverage. Under Total TLC, we provide customers with full spare parts coverage, including installation service by a TomoTherapy field service engineer and full planned maintenance. We recognize service contract revenue ratably over the term of the contract. We recognize optional equipment and software revenue upon shipment to the customer. For arrangements with multiple elements, we recognize revenue for each element based on fair value of the element provided when all other criteria for revenue recognition have been met. The fair value for each element provided in multiple element arrangements is determined by referencing historical pricing policies applicable when the element is sold separately. See “Critical Accounting Policies and Estimates — Revenue Recognition.”

 

Customer concentration.   In the years ended December 31, 2005 and 2006, no single customer accounted for more than 10% of our revenue in each period.

 

Geographic breakdown.   The following table sets forth the geographic breakdown of our revenue for the periods indicated:

 

 

Distributor sales.   In certain Asian countries, we sell the Hi Art system through distributors, who, in turn, sell the system directly to end customers. Our standard distributor agreement requires us to assist the distributor with the initial four installations of Hi Art systems within that distributor’s region. Following these first four installations, the distributor is obligated to perform all post-shipment services required under the purchase agreement, including installation, testing, training and post-installation warranty service. Distributors do not have a contractual right of return if the sale to an end customer is not completed. We have developed a certification procedure to ensure distributors can fulfill these obligations, which includes an evaluation of the distributor’s financial stability. Upon completion of our certification program, the certified distributor is deemed by us to be qualified to install and service the Hi Art system and our personnel are no longer involved in the installation or acceptance test procedures. During the fourth quarter of 2006, our Japanese distributor, Hi Art Co., Ltd., became the first distributor to achieve certification. Prior to a distributor achieving certification, we recognize revenue upon receipt of the signed acceptance procedure document from the end customer. After certification, we recognize revenue upon shipment to the distributor.

 

Sales agents.   In Europe, we use sales agents to identify potential end customers and assist our sales and marketing personnel with negotiations and closing sales of the Hi Art system to end customers. Our standard sales agent agreement provides for payment of our sales agents on a commission basis.

 

Cost of revenue

 

Cost of revenue consists of material, labor and overhead costs incurred in the manufacture of the Hi Art system. It also includes the cost of shipping the system to the customer site, installation costs, a warranty accrual and a royalty payment to WARF. A significant component of cost of revenue is the customer support and service infrastructure required to service and repair the equipment during the warranty period and thereafter, when covered by a service contract. The cost of replacement parts makes up a significant portion of repair costs.

 

In future periods, we expect our cost of revenue to decrease as a percentage of total revenue due to improved absorption of manufacturing overhead costs and reduced material costs associated with increased volumes. We also plan to introduce several component design changes that should result in lower costs and higher reliability than our current components.

 

Most of our existing service contracts currently have negative gross profit margins. We recorded a reserve for the estimated losses on these service contracts. We expect to narrow these negative margins and begin to generate positive margins over time by increasing the price for our annual service contracts and leveraging our fixed service infrastructure costs over a larger installed base. We also expect a decline in our service costs due to improved training of our field service engineers combined with a larger number of systems in each engineer’s territory. Finally, we believe that the introduction of several component design changes should also improve system performance which should in turn reduce our service costs.

 

Research and development expenses

 

Research and development expenses consist primarily of salary and benefits for research and development personnel. Research and development also includes expenses associated with product design and development, customer research collaborations and third parties who furnish services related to these activities.

 

We expect research and development expenses will continue to increase in absolute terms in the next 12 months as we increase the total number of employees performing research and development activities.

 

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, promotional and marketing materials and expenses related to accounting, legal, tax and other consulting fees. We expect selling, general and administrative expenses will continue to increase in the next 12 months both in absolute dollars and as a percentage of revenue as we hire the staff necessary to meet the reporting requirements of a public company, increase the total number of employees and incur additional costs related to the overall growth of our business.

 

Other income (expense), net

 

Other income is primarily interest income earned on our cash and cash equivalents. Other expense is primarily the expense related to the increase in fair value of the convertible preferred stock warrant liability beginning January 1, 2006, banking fees related to standby letters of credit required to support some of our international orders and interest expense on borrowings. This category also includes foreign currency gain and losses on customer deposits made on sales contracts denominated in Euros. We currently do not hedge these foreign currency contracts.

 

Key Factors Affecting our Performance

 

Our business, financial position and results of operations, as well as the period-to-period comparability of our financial results, are significantly affected by a number of factors, some of which are beyond our control, including the following:

 

Extended sales cycle and fluctuations.   The Hi Art system has a lengthy sales cycle, with the time from initial customer contact to execution of a purchase order generally lasting up to one year or more. Following execution of a contract, it may take several months for a customer to renovate a facility to house the Hi Art system and between nine and twelve months for new bunker construction. Upon delivery of the Hi Art system, it generally takes three to four weeks to complete the installation and testing of the system, including the completion of acceptance test procedures with the customer. With the exception of our Japanese distributor, we recognize revenue from the sale of the Hi Art system upon receipt of a signed acceptance test procedure document from the customer. We recognize sales of the Hi Art system upon shipment to our Japanese distributor pursuant to our distributor certification program. Due to the high unit price of the Hi Art system and the relatively small number of units installed each quarter, each installation represents a significant component of our revenue for a particular period. Therefore, if a small number of customers defer installation of the Hi Art system for even a short time, recognition of a significant amount of revenue may be deferred to a subsequent period. As a result of these factors, our revenue could fluctuate significantly from period to period and may not represent an accurate measure of the overall performance of our business. We believe that our quarterly results of operations should be viewed in light of our backlog of orders, which provides a better measure at any particular point in time of the long-term performance prospects of our business.

 

Customer mix and gross margins.   Our mix of customers impacts our average selling prices and our gross margins:

 

 

 

 

Component supply and cost.   Our cost of revenue as a percentage of total revenue was 61.8% for 2004, 66.1% for 2005 and 65.8% for 2006. Our gross margins have been impacted by higher component costs and higher failure rates than we originally anticipated, resulting in increased warranty expense and negative profit margins on many service contracts. We believe that these higher component costs and failure rates resulted both from smaller initial production volumes and from our reliance on sole-source suppliers for a number of key components. We are investing in developing alternate components and in implementing enhancements to increase the performance of components currently used in the Hi Art system. We will also seek to identify lower priced components of comparable and improved performance and quality, as well as make engineering improvements to the Hi Art system in order to reduce costs. We believe that achieving these goals should result in improved gross margins in the long term.

 

Operating expenses.   We have significantly expanded our total number of employees over the last three years from 171 at December 31, 2004, to 327 as of December 31, 2005, and to 492 as of December 31, 2006, due primarily to expansion of our research and development, service and support and sales and marketing capabilities. Our operating expenses are relatively fixed, consisting primarily of salaries, benefits and related overhead. Accordingly, we cannot generally make significant adjustments in response to short-term fluctuations in quarterly revenue. We also expect that our operating expenses will increase in absolute terms, but decrease as a percentage of our total revenue as we leverage our existing infrastructure.

 

 

The results for the year ended December 31, 2006 include a $7.8 million benefit from deferred income taxes.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2006

 

Revenue

 

Revenue increased from $75.8 million for the year ended December 31, 2005 to $156.1 million for the year ended December 31, 2006, an increase of $80.3 million or 106.1%. This increase resulted primarily from an increase in the number of Hi Art systems accepted. We received acceptances on 89% more systems during the year ended December 31, 2006, than were received during the year ended December 31, 2005. In addition, the average selling price per system increased by approximately 5% due primarily to our international expansion. During the year ended December 31, 2005, 78% of our revenue was generated in North America compared to 57% during the year ended December 31, 2006, as we expanded our presence in international markets.

 

Service revenue increased from $1.8 million for the year ended December 31, 2005 to $6.7 million for the year ended December 31, 2006, as more systems reached the end of their warranty period and customers elected to enter into service contracts with us.

 

Cost of revenue

 

Cost of revenue increased from $50.0 million for the year ended December 31, 2005 to $102.7 million for the year ended December 31, 2006, an increase of $52.6 million or 105.1%. This increase was attributable

to the number of systems accepted and the growth in our service infrastructure. Gross margins were 33.9% and 34.2% for the years ended December 31, 2005 and 2006, respectively. The increase in gross margins was due to our higher sales volume which resulted in improved absorption of manufacturing overhead costs. This increase was partially offset by higher service costs due to our continued investment in building service infrastructure and negative margins on service contract revenue.

 

Research and development expenses

 

Research and development expenses increased from $11.4 million for the year ended December 31, 2005 to $21.4 million for the year ended December 31, 2006, an increase of $10.0 million or 88.2%. The increase was primarily attributable to $6.1 million in additional employee costs due to an increase in the total number of employees engaged in research and development activities from 90 at December 31, 2005 to 139 at December 31, 2006, as we accelerated the work on future product initiatives. We also incurred an additional $3.0 million in external consulting expenses for development projects in 2006. As a percentage of revenue, total research and development expenses were 15.0% and 13.7% for the years ended December 31, 2005 and 2006, respectively.

 

Selling, general and administrative expenses

 

Selling, general and administrative expenses increased from $14.2 million for the year ended December 31, 2005 to $23.1 million for the year ended December 31, 2006, an increase of $8.9 million or 62.8%. The increase was primarily due to an increase of $4.4 million in employee costs as the total number of employees engaged in selling, general and administrative activities increased from 74 at December 31, 2005 to 111 at December 31, 2006, due to the expansion of our business. In addition, we incurred a $1.5 million increase in commissions as a result of the increased sales and slightly higher commission rates, and an additional $1.2 million expense for accounting, tax and legal services. We also incurred a $0.7 million increase in travel-related expenses due to the increase in size and geographical spread of our operations. As a percentage of revenue, selling, general and administrative expenses were 18.7% and 14.8% for the years ended December 31, 2005 and 2006, respectively.

 

Other income (expense), net

 

We had other income of $0.2 million for the year ended December 31, 2005, and other expense of $1.2 million for the year ended December 31, 2006, a change of $1.4 million. The primary reason for this change was an expense of $0.9 million for the increase in fair value of the convertible preferred stock warrants. We also incurred foreign currency losses on customer deposits made on sales contracts denominated in Euros, which was largely offset by higher revenue on those orders. We have not hedged these foreign currency contracts.

 

Income tax expense (benefit)

 

Income tax expense changed from a provision of $0.1 million for the year ended December 31, 2005 to a $7.2 million benefit for the year ended December 31, 2006, a change of $7.3 million. This change resulted from the reversal of a portion of our deferred tax asset valuation allowance. As of December 31, 2006, we had federal and state net operating loss carryforwards of $15.6 million and $19.1 million, respectively. These federal and state net operating loss carryforwards are available to offset future taxable income, if any, and will begin to expire in varying amounts beginning in 2022 and 2016 for federal and state purposes, respectively. While we had income in 2005, based on the objective evidence and history of losses, we maintained a full valuation allowance on our net deferred tax assets as we concluded that it was more likely than not that such benefits would not be realized. As of December 31, 2006, based on our analysis of all positive and negative factors, including the fact that we had realized net income during three successive fiscal years, we determined that approximately $10.5 million of the deferred tax assets were more likely than not to be realized. This assessment was based on a determination that we would utilize our net operating loss carryforwards in approximately two years based on our current taxable income level. Offsetting this tax benefit was a $1.9 million reduction in deferred tax assets related to an excess tax benefit stock option deduction.

This tax benefit will be accounted for directly in equity as additional paid in capital as the stock option-related deduction reduces taxes payable.

 

For the year ended December 31, 2006, we completed a similar analysis and found considerably more positive evidence. The number of systems sold had increased substantially, profit margins increased, three years of cumulative profit and significant growth year over year in taxable income. In addition, we had more visibility into our 2007 projected performance due to the number of orders we received in 2006 and the final backlog numbers. As a result of these developments, we determined that the majority of the valuation allowance could be released.

 

The weight given to the potential effect of negative and positive evidence was commensurate with our ability to objectively verify it. For the years ended December 31, 2004 and 2005, we had a significant three-year cumulative loss. Although we had net income in each of those years, we were only marginally profitable. These factors were given greater weighting since they could be measured objectively. Conversely, there was not enough positive evidence to conclude that the valuation allowance could be reduced at that time.

 

Our taxable income in 2006 was $8.7 million. If we maintain this level of taxable income in future fiscal years, we would expect to utilize our federal net operating loss carryforwards in two years or a shorter period if our net income increases further.

 

Year Ended December 31, 2004 Compared to Year Ended December 31, 2005

 

Revenue

 

Revenue increased from $45.5 million for the year ended December 31, 2004 to $75.8 million for the year ended December 31, 2005, an increase of $30.3 million or 66.6%. This growth resulted from both an increase in the number of systems accepted and an increase in the average selling price. We had 40% more systems accepted during the year ended December 31, 2005, compared to the year ended December 31, 2004. In addition, the average selling price of the Hi Art system increased 17% during the period as we raised prices and further penetrated international markets, which produced higher prices than in the United States. During the year ended December 31, 2004, 94% of our revenue was generated in North America compared to 78% in 2005, as we expanded our presence in international markets.

 

Service revenue was less than $0.1 million for the year ended December 31, 2004 compared to $1.8 million for the year ended December 31, 2005, an increase of $1.7 million. The first of our post-warranty service contracts became effective in the second half of 2004 as the first installed Hi Art systems reached the end of their warranty periods and customers elected to enter into service agreements with us.

 

Cost of revenue

 

Cost of revenue increased from $28.1 million for the year ended December 31, 2004 to $50.0 million for the year ended December 31, 2005, an increase of $22.0 million or 78.2%. Gross margins were 38.2% and 33.9% for the years ended December 31, 2004 and 2005, respectively. The decrease was attributable to an increase in the number of systems accepted and our higher investment in our service infrastructure.

 

Research and development expenses

 

Research and development expenses increased from $6.5 million for the year ended December 31, 2004 to $11.4 million for the year ended December 31, 2005, an increase of $4.9 million or 75.2%. The increase was primarily attributable to an increase of $3.3 million in additional employee costs due to an increase in the number of employees engaged in research and development activities from 50 at December 31, 2004 to 90 at December 31, 2005, in connection with an increased number of development projects. We also incurred an additional $1.2 million in external consulting expenses for engineering related projects in 2005. As a percentage of revenue, research and development expenses were 14.3% and 15.0% for the years ended December 31, 2004 and 2005, respectively.

 

Selling, general and administrative expenses

 

Selling, general and administrative expenses increased from $7.8 million for the year ended December 31, 2004 to $14.2 million for the year ended December 31, 2005, an increase of $6.4 million or 81.4%. The increase primarily resulted from an increase of $2.7 million in employee costs related to increasing the number of employees in sales, marketing and other corporate activities from 44 at December 31, 2004 to 74 at December 31, 2005. In addition, we incurred a $1.0 million increase in commission expense as a result of increasing sales and slightly higher commission rates, a $0.7 million increase in travel-related expenses related to the growth of the company, a $0.6 million increase in accounting, tax and legal services, and a $0.5 million increase in expenses related to trade shows and other meetings. As a percentage of revenue, selling, general and administrative expenses were 17.2% and 18.7% for the years ended December 31, 2004 and 2005, respectively.

 

Other income (expense), net

 

Other expense was $31,000 during the year ended December 31, 2004 compared to other income of $179,000 during the year ended December 31, 2005, a change of $210,000. The primary reason for this increase was an increase in interest earned on higher cash and cash equivalents from the receipt of more customer deposits due to a higher number of orders. This cash was invested in a money market account throughout the year.

 

Income tax expense (benefit)

 

Income tax expense decreased from $151,000 for the year ended December 31, 2004 to $78,000 for the year ended December 31, 2005, a decrease of $73,000. This decrease was due to a decrease in earnings which was partially offset by the filing of tax returns in additional states and the impact of the federal alternative minimum tax.

 

Quarterly Results of Operations

 

The table below sets forth selected unaudited consolidated statements of operations data for each of the eight consecutive quarters in the period ended December 31, 2006. In management’s opinion, these unaudited consolidated statements of operations have been prepared on the same basis as our audited consolidated financial statements contained elsewhere in this prospectus and include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such financial information. This information should be read in conjunction with the audited consolidated financial statements and notes thereto appearing elsewhere in this prospectus.

 

 

Our quarterly revenue and results of operations have varied significantly in the past and can be expected to vary in the future due to numerous factors. Many of our operating expenses are relatively fixed and we expect them to increase over time as we continue to make the investments necessary for future growth, yet our quarterly revenue depends on the timing of the installation and receipt of the customers’ acceptance of the Hi Art system in their facilities. Therefore, our operating results have fluctuated from quarter to quarter and we have incurred quarterly losses even during years when we reported profits on an annual basis. Many of these factors are discussed in “Key Factors Affecting our Performance.”

 

We believe that our backlog levels provide a better measure at any particular point in time of the long-term performance prospects of our business. A significant portion of our revenue each quarter is derived from our backlog. The level of backlog will fluctuate based on our customers’ ordering patterns and the timing of the completion of the acceptance test procedures necessary for revenue recognition. However, the majority of our backlog has historically been converted to revenue within twelve months of order placement. Accordingly, our backlog has been a general indicator of the revenue expected to be recognized over the next year, when combined with the new sales contracts entered into early in the year.

 

As a result of these factors, we believe that quarter-over-quarter comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance.

 

Recent Developments

 

Although our financial statements for the quarter ended March 31, 2007 are not yet complete, the following revenue and backlog information reflects our estimate of our results based on currently available information. We estimate that revenues for the three months ended March 31, 2007 were between $50.0 million and $52.0 million, compared with revenues of $27.5 million for the three months ended March 31, 2006, and

$59.6 million for the three months ended December 31, 2006. The increase in year-over-year quarterly revenues resulted primarily from increased Hi Art system sales. The decrease in revenues from the most recent prior quarter resulted primarily from the timing of installation and receipt of customers’ acceptance of the Hi Art system in their facilities. As of March 31, 2007, we estimate that our backlog was approximately $162 million, the significant majority of which we expect to deliver within the next 12 months.

 

The foregoing revenue and backlog information is not a comprehensive statement of our financial results for the quarter ended March 31, 2007. The foregoing information should therefore be considered together with our full results of operations when published. The foregoing information is subject to adjustment based upon, among other things, the finalization of our quarter-end closing and reporting processes. The estimates for any interim period are not necessarily indicative of our operating results for a full year or any future period, and are qualified in their entirety by, and should be read in conjunction with our consolidated financial statements.

 

the reduction in the level of customer deposits was primarily due to the timing of such payments. We also experienced an increase in accounts receivable of $3.3 million and inventory of $7.6 million. These were both largely due to more Hi Art systems being shipped close to the end of the year and waiting final acceptance.

 

Cash flows from investing activities.   During the year ended December 31, 2006, we used net cash of $11.0 million to purchase capital equipment as we (1) completed the build-out of our new leased manufacturing facility, (2) completed the build-out of our European office in Brussels, Belgium, and (3) implemented our new enterprise resource planning system from SAP. We also invested $4.7 million in test systems for internal development, training and testing of manufacturing components.

 

Net cash used in investing activities was $3.6 million and $4.2 million for the years ended December 31, 2004 and 2005, respectively. The net cash used in investing activities was primarily for the purchase of furniture and equipment related to expanding our office space and hiring new employees in Madison, Wisconsin.

 

Cash flows from financing activities.   Net cash from financing activities was $1.9 million for the year ended December 31, 2006. We entered into two loans during this period: $0.5 million from the State of Wisconsin Technology Development Fund and $0.4 million from Madison Development Corporation for capital improvements to our new leased manufacturing facility in Madison, Wisconsin. We also received $1.0 million in proceeds from the exercise of employee stock options.

 

Net cash provided from financing activities was $4.9 million and $14.2 million for the years ended December 31, 2004 and 2005, respectively. Net cash provided from financing activities for fiscal years 2004 and 2005 were proceeds received from the issuance of preferred stock. We sold 2.8 million shares of Series D preferred stock for $4.9 million in 2004, net of the conversion of $1.8 million of notes payable, and 1.7 million shares of our Series E preferred stock for $13.9 million in 2005.

 

Loans and Available Borrowings

 

We maintain an unsecured $30.0 million line of credit with a bank, which bears interest at the London Interbank Offered Rate plus 2.5% or at the prime rate plus 0.25% and is adjusted based on the ratio of our total liabilities to tangible net worth. Among other requirements, the line of credit contains several covenants, the primary ones being a requirement to maintain a backlog of at least $60.0 million and tangible net worth of at least $17.0 million. We are in compliance with all such covenants. There were no outstanding borrowings under the line for any of the periods included in this prospectus.

 

On February 13, 2006, we entered into a $0.4 million note payable with Madison Development Corporation. The note payable bears interest at 4.0%, is payable in monthly installments of $4,050 and the remaining unpaid principal is due on March 1, 2011. The note payable is secured by a second position in all of our equipment, fixtures, inventory, general intangibles and contract rights. The outstanding principal balance at December 31, 2006 was approximately $0.4 million.

 

On November 28, 2005, we entered into a $0.5 million note payable agreement with the Wisconsin Department of Commerce and received the principal balance in June 2006 in accordance with the requirements of the agreement. The note payable bears interest at 2.0%, is payable in monthly installments of $8,647 and the remaining unpaid principal is due on March 1, 2013. The outstanding principal balance at December 31, 2006 was $0.5 million.

 

 

The table of contractual obligations and commitments does not include royalty payments payable to the Wisconsin Alumni Research Foundation under a license agreement, dated February 22, 1999. The amount of royalty payments is based on the number of units of the Hi Art system sold and therefore cannot be determined accurately in advance. Our royalty expenses under the license agreement are currently significantly in excess of minimum required payments and were $504,000 in 2004, $672,000 in 2005 and $1.3 million in 2006.

 

Operating Capital and Capital Expenditure Requirements

 

Our future capital requirements depend on numerous factors. These factors include, but are not limited to, the following:

 

 

We believe that our current cash and cash equivalents, along with the cash we expect to generate from operations and our net proceeds from this offering, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. If our estimates of revenue, expenses, or capital or liquidity requirements change or are inaccurate, or if cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or arrange additional debt financing. In the future, we may also seek to sell additional equity or arrange debt financing to give us financial flexibility to pursue attractive acquisition or investment opportunities that may arise, although we currently do not have any acquisitions or investments planned. We may also seek to sell additional equity or arrange debt financing to provide us with additional financial flexibility if market opportunities exist.

 

Off-Balance Sheet Arrangements

 

As of December 31, 2006, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

 

Quantitative and Qualitative Disclosures about Market Risk

 

Market risk is the risk of loss related to changes in market prices, including interest rates and foreign exchange rates, of financial instruments that may adversely impact our consolidated financial position, results of operations or cash flows.

 

Interest Rate Risk

 

Our investments consist primarily of investments in money market funds. While the instruments we hold are subject to changes in the financial standing of the issuer of such securities, we do not believe that we are subject to any material risks arising from changes in interest rates, foreign currency exchange rates,

commodity prices, equity prices or other market changes that affect market risk sensitive instruments. It is our policy not to enter into interest rate derivative financial instruments. As a result, we do not currently have any significant interest rate exposure.

 

The interest rate under our line of credit is subject to change based on the London Interbank Offered Rate or the prime rate. We do not currently have any borrowings under our line of credit.

 

Foreign Currency Exchange Rate Risk

 

A significant portion of our sales and expenses historically have been denominated in U.S. dollars. As a result, we have not experienced significant foreign exchange gains or losses to date. For the year ended December 31, 2006, 15% and 1% of our revenue was from contracts denominated in Euros and Canadian dollars, respectively. During 2006, we opened and staffed an office in Brussels, Belgium and began incurring Euro-denominated expenses, which were paid directly from the U.S. We currently do not hedge our foreign currency since the exposure has not been material to our historical operating results. To date, our Euro-denominated sales orders have included high down payments, limiting the need to hedge the related currency risk. Future fluctuations in the value of the U.S. dollar may affect the price competitiveness of the Hi Art system outside the United States. To the extent that we can predict the timing of payments under these contracts, we may engage in hedging transactions to mitigate such risks in the future.

 

Inflation

 

Our operations have not been, and we do not expect them to be, materially affected by inflation. Historically, we have been successful in adjusting prices to our customers to reflect changes in our material and labor costs.

 

Critical Accounting Policies and Estimates

 

This discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as revenue and expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors we believe are 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 could therefore differ materially from those estimates under different assumptions or conditions. Our significant accounting policies are more fully described in the notes to our consolidated financial statements included elsewhere in this prospectus. We believe the following are our critical accounting policies including the more significant estimates and assumptions used in preparation of our consolidated financial statements. With respect to our policies on revenue recognition, inventories and warranty costs, our historical experience is based principally on our operations since 2003 when we commenced selling the Hi Art system.

 

Revenue Recognition

 

We recognize revenue from system product sales and related services when earned in accordance with Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition , and Emerging Issues Task Force Issue (“EITF”) No. 00-21, Revenue Arrangements with Multiple Deliverables. Revenue is recognized when the following four criteria are met:

 

 

 

Payments received for products or services prior to shipment or prior to completion of the related services 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.

 

We recognize revenue in connection with distributor sales of the Hi Art system based on the distributor’s certification status. Once a distributor is certified by us to provide installation, testing, training and post-installation warranty services to end customers, we recognize revenue upon shipment to that certified distributor as we no longer have any obligations to the distributor or the end customer. Prior to a distributor achieving certification, we recognize revenue upon receipt of the signed acceptance procedure document from the end customer. Our distributors do not have any contractual right to return and we have not accepted any returns to date. As of December 31, 2006, we had only certified our Japanese distributor.

 

We frequently enter into sales arrangements with customers that contain multiple elements or deliverables such as hardware and post-warranty maintenance services. Judgments as to the allocation of the proceeds received from an arrangement to the multiple elements, the determination of whether the undelivered elements are essential to the functionality of the delivered elements and the appropriate timing of revenue recognition are critical to ensure compliance with U.S. GAAP. The ability to establish the fair value of those elements could affect the timing of revenue recognition. For arrangements with multiple elements, we recognize revenue for each element based on the fair value of the element provided when all other criteria for revenue recognition have been met. The fair value for each element provided in multiple element arrangements is typically determined by referencing historical pricing policies when the element is sold separately. Changes in our ability to establish the fair value for each element in multiple element arrangements could affect the timing of revenue recognition.

 

Revenue allocated to maintenance and support on the Hi Art system is recognized ratably over the term of the service agreement, which ranges from twelve to thirty-six months.

 

In 2006, we began selling an optional software package separately from the Hi Art system. The selling price, cost and functionality of this software is incidental to the operation of the Hi Art system itself. We recognize revenue for this software in accordance with SOP No. 97-2, Software Revenue Recognition , as amended by SOP No. 98-9, Software Revenue Recognition with Respect to Certain Agreements. We recognize license revenue 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 under SOP No. 97-2 have been met. Revenue earned on software arrangements involving multiple elements are allocated to each element based on vendor specific objective evidence of fair value, which is based on the price charged when the same element is sold separately. In instances when evidence of fair value of all undelivered elements exists, but evidence does not exist for one or more delivered elements and the fair value of all 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.

 

Inventories

 

Inventories are valued at the lower of cost or market, determined by the FIFO method. We regularly review our inventory quantities on hand and record a provision for excess or obsolete inventory primarily based on our estimated forecast of product demand and existing product configurations. Our inventories are subject to rapid technological change. As changes to the product are released, a determination must be made to identify any parts that are no longer useful. If a part is determined to be obsolete, a reserve is recorded for the value of the inventory on hand. We also forecast usage and compare this with the quantity of parts on hand. If it is determined we have excess inventory, a reserve is established for the excess.

 

Warranty Obligations

 

We warrant the Hi Art system for a period of twelve months following customer acceptance. We record a current liability for the expected cost of warranty obligations in cost of revenue at the time when each sale is recognized. The accrued warranty costs represent the best estimate of the total costs that we will incur to repair or replace parts that fail while the system is under warranty. An analysis is completed on a regular basis to update the historical trend data and to determine if the accrued balance is sufficient to meet our outstanding warranty obligations. The amount of our estimated warranty liability currently is approximately 6% of the sales value of the Hi Art system and may be adjusted as the costs incurred increase or decrease in the future.

 

Income Taxes

 

We account for federal and state income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Under the liability method specified by SFAS No. 109, a deferred tax asset or liability is determined based on the difference between the financial statement and tax basis of assets and liabilities, as measured by the enacted tax rates. As of December 31, 2006, we had federal and state net operating loss carryforwards of $15.6 million and $19.1 million, respectively. These federal and state net operating loss carryforwards are available to offset against future taxable income, if any, and will begin to expire in varying amounts beginning in 2022 and 2016 for federal and state purposes, respectively. Utilization of the net operating loss carryforwards may be subject to an annual limitation due to the ownership percentage change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of the net operating loss carryforwards before utilization.

 

The valuation allowance was determined in accordance with SFAS No. 109, which requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable. During 2005, we fully reserved all net deferred tax assets, which were predominantly net operating loss and tax credit carryforwards. During 2006, however, it was determined the deferred tax assets were more likely than not realizable based upon our history of and future projections of earnings. We reversed $10.5 million of the deferred tax asset valuation allowance during the year ended December 31, 2006.

 

Stock-Based Compensation

 

Effective January 1, 2006, we adopted SFAS 123(R), Share-Based Payment , which is a revision of SFAS Statement No. 123 (SFAS 123), Accounting for Stock-Based Compensation. SFAS 123(R) requires all share-based payments to employees, including grants of employee and director stock options, to be recognized in our income statement based on their fair values. Pro forma disclosure is no longer an alternative.

 

As permitted by SFAS 123, we historically accounted for share-based payments to employees using SFAS 123 using the minimum value method and are required to apply the prospective transition method of SFAS 123(R). Under the prospective method, only new awards (or awards modified, repurchased, or cancelled after the effective date) are accounted for under the provisions of SFAS 123(R).

 

We selected the Black-Scholes pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model will be affected by assumptions regarding a number of complex and subjective variables. These

variables include our expected stock volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates, forfeitures and expected dividends.

 

The expected term represents the weighted-average period that our stock options are expected to be outstanding. The expected term is based on a simplified or “plain vanilla” approach as we do not feel our historical experience is reasonable or supportable. In order to qualify for the simplified approach, SAB 107 provides five criteria the stock option must meet. Our stock options meet those criteria and therefore, we used this approach for all stock options granted in 2006. As we have been operating as a private company since inception, we are unable to use our actual price volatility data. Therefore, we estimate the volatility of our common stock based on volatility of similar entities over the expected term of our stock options. We base the risk-free interest rate that we use in the option pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. We do not anticipate paying any cash dividends in the foreseeable future and, therefore, use an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The current forfeiture rate was based on our past history of pre-vesting forfeitures.

 

We had a choice of two attribution methods for allocating compensation costs under SFAS No. 123(R) the “straight-line method,” which allocates expense on a straight-line basis over the requisite service period of the last separately vesting portion of an award, or the “graded vesting attribution method,” which allocates expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards. We chose the former method and amortized the fair value of each option on a straight-line basis over the service period.

 

Based on the variables affecting the valuation of our common stock and the method used for allocating compensation costs, we recognized $232,000 in stock compensation expense during the year ended December 31, 2006.

 

Calculating stock-based compensation expense requires the input of highly subjective assumptions, which represent our best estimates and involve inherent uncertainties and the application of management’s judgment. Estimates of stock-based compensation expenses are significant to our financial statements, but these expenses are based on the Black-Scholes pricing model and will not result in the payment of cash by us.

 

The guidance in SFAS No. 123(R) and Staff Accounting Bulletin No. 107 is relatively new, and best practices are not well established. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among option valuation models, and this may result in a lack of comparability with other companies that use different models, methods and assumptions. If factors change and we employ different assumptions in the application of SFAS No. 123(R) in future periods, or if we decide to use a different valuation model, the compensation expense that we record in the future under SFAS No. 123(R) may differ significantly from what we have recorded in the current period and could materially affect our operating loss, net loss and net loss per share.

 

With respect to each option grant date, we determine the deemed fair value of our common stock. As there is no public market for our common stock, this determination was necessarily subjective. In making this determination, we considered a number of factors, including:

 

 

We have reviewed the methodologies used in making these determinations in light of the AICPA’s Practice Aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation , which we refer to as the practice aid. We took into consideration the market and income approaches to valuation as set forth

in the practice aid. We believe that the valuation methodologies that we have used are consistent with the practice aid.

 

In connection with the preparation of our financial statements for the years ended December 31, 2005 and 2006, we assessed the valuations of our common and preferred shares as of the applicable grant dates primarily by considering recent third-party transactions in our common stock and the issuance price of our preferred stock in sales to third parties. Because all of such transactions were negotiated by the parties on an arms’-length basis, we determined that the prices paid in those transactions reflected a reliable determination of the fair value of our securities. When no such recent stock activity occurred, we engaged an independent valuation firm, Virchow Krause Valuation, LLC (Virchow Krause), to perform independent valuations of our common stock.

 

Valuation Methodologies Employed by Virchow Krause

 

The valuation methodologies employed by Virchow Krause in connection with the independent valuation studies were based on various generally accepted valuation methods. Specifically, at each valuation date Virchow Krause analyzed the value of our securities based on three potential scenarios: a public offering, a sale or merger and remaining a private company.

 

In each of Virchow Krause’s reports, each of these scenarios was analyzed using a different valuation methodology. Specifically, (i) valuation in connection with the public offering scenario was calculated by reference to the public market prices of companies in our industry or industries deemed by Virchow Krause to be similar, reviewing various valuation multiples implied by the trading prices of such companies, and applying those multiples to our financial performance; (ii) valuation in connection with the sale or merger scenario was calculated by reference to recent transactions involving businesses in our industry or industries determined by Virchow Krause to be similar, reviewing various valuation multiples implied by the prices in those transactions, and applying those multiples to our financial performance; and (iii) valuation in connection with the private company scenario was calculated using the discounted cash flow valuation method, applying a forecast of future cash flows (determined by our management and Virchow Krause to be reasonable), an appropriate discount rate (calculated to be our weighted average cost of capital) and a residual value (determined by capitalizing our stabilized cash flow). Following these analyses, Virchow Krause allocated the values so determined to our preferred stock and our common stock based on the economic impact of the conversion rights and liquidation preferences of the preferred stock, and assigning probabilities to each of these events that varied depending upon our stage of development and our financial condition. In making its valuations, Virchow Krause applied discounts based on a number of factors that it determined impacted the value of our common stock. First, it applied a discount with respect to the sale or merger scenario and the private company scenario to reflect the fact that the common stock being valued did not represent a controlling interest in our company. Second, it applied a discount to reflect the lack of marketability of our common stock. As of March 31, 2006, the discount applied for each of the lack of control and the lack of marketability was 10% respectively. As of December 31, 2007 no discount was applied for either factor due to the increased likelihood of an initial public offering or a sale or merger. Third, it applied a discount to reflect the lesser rights of the common stock compared to the preferred stock. As of March 31, 2006, the discount applied was 22% and as of December 13, 2006, the discount applied was 3%, reflecting the increased probability of an exit event that would result in conversion of the preferred stock. Finally, for the December 31, 2006 valuation it applied a discount of 7.5% with respect to the public company scenario to reflect the fact that an initial public offering was not expected to occur until June 1, 2007.

 

In addition, for each valuation report Virchow Krause reviewed our historical financial performance, conducted a visit of our facilities and interviewed our management concerning our business and its prospects. Virchow Krause also researched our industry, customers, competitors, suppliers and prospects, and analyzed the economic outlook of the industry and the community in which we operate.

 

Determining the fair value of our common stock involves complex and subjective judgments involving estimates of revenue, earnings, assumed market growth rates and estimated costs, as well as appropriate discount rates. At the time of each valuation, the significant estimates used in the discounted cash flow approach included estimates of our revenue and revenue growth rates for several years into the future. Although each time we prepared such forecasts for use by Virchow Krause in the preparation of a valuation

report, we did so based on assumptions that we believed to be reasonable and appropriate, there can be no assurance that any such estimates for earlier periods have come to pass or that any such estimates for future periods will prove to be accurate.

 

The aggregate intrinsic value of our options outstanding at December 31, 2006 was $116.3 million of which $50.3 million related to vested options. The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock options and $16.00 per share, the midpoint of the estimated initial public offering price range.

 

 

Intrinsic value per share is the difference, as of the grant date, between the fair value estimate and the exercise price.

 

The major pricing factors which supported the valuations used at each of the grant dates were as follows:

 

 

 

Convertible Preferred Stock Warrant Liability

 

Effective January 1, 2006, we accounted for warrants that are exercisable into redeemable preferred shares issued in connection with financing arrangements in accordance with FSP 150-5. Pursuant to FSP 150-5, an evaluation of specifically identified conditions is made to determine whether the fair value of warrants issued is required to be classified as a liability. The fair value of warrants classified as liabilities is adjusted for changes in fair value at each reporting period, and the corresponding non-cash gain or loss is recorded in current period earnings. We selected the Black-Scholes option pricing model to determine the fair value of warrants. The determination of the fair value using this model will be affected by assumptions regarding a number of complex and subjective variables. These variables include our expected stock volatility over the expected term of the warrant, risk-free interest rates, and the estimated fair value of the underlying preferred stock. The expected term used was equal to the remaining contractual term of the warrants. As we have been operating as a private company since inception, we were unable to use our actual stock price volatility data. Therefore, we estimated the volatility of the underlying stock based on historical stock prices of companies which we consider to be members of our peer group. Historical price volatilities of these companies were evaluated over a period of time equal to the expected term of the warrants. The risk-free interest rates were based on U.S. Treasury zero-coupon rates in effect at each reporting period with terms consistent with the expected term of the warrants. The fair value of the underlying preferred stock at January 1, 2006 was determined based upon the sale by us of 2,356,435 shares of Series E preferred stock at $5.94 per share on December 29, 2005 and an independent third-party valuation performed by Virchow Krause which allocated our enterprise value, determined based upon the sale of the Series E preferred stock, to each of our existing classes of stock including the Series A and D preferred stock. The fair value of the underlying Series A and D preferred stock at December 31, 2006 was determined based upon an independent third-party valuation performed by Virchow Krause. This valuation, as of December 31, 2006, was prepared utilizing the probability weighted expected return method as prescribed by the AICPA Practice Aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation. This valuation took into consideration the following scenarios: (i) completion of an initial public offering; (ii) sale or merger; and (iii) remaining private. The valuation amounts determined under each scenario were then probability weighted based upon our management’s best estimates of the occurrence of each scenario. The resulting value was then allocated to our common and each series of preferred stock based upon the economic impact of the conversion rights and liquidation preferences of the preferred stock.

 

Redeemable Convertible Preferred Stock

 

We have issued various classes of preferred stock. The holders of Series A, B, C and D preferred stock have the option to put their shares back to us at the greater of the original purchase price plus accrued dividends, or the current fair market value of the shares. The holders of Series E preferred stock have the option to put their shares back to us at the original purchase price plus accrued dividends. As a result, the

carrying value of the preferred stock has been increased by an accretion each period so that the carrying amounts will equal the greater of fair value or the defined redemption value for the Series A, B, C and D preferred stock. The Series E preferred stock has been increased to its redemption value, including accrued dividends. The accreted amounts are recorded to accumulated deficit. The put option and the related accretion of the preferred shares will terminate upon the closing of this offering. The fair value of the underlying preferred stock at January 1, 2006 and the fair value of the underlying Series A and D preferred stock at December 31, 2006 was determined as described in “— Convertible Preferred Stock Warrant Liability” above.

 

Recent Accounting Pronouncements

 

In May 2005, the FASB issued Statement 154, Accounting Changes and Error Corrections  — a replacement of APB Opinion No. 20 and Financial Accounting Standards Board (FASB) Statement No. 3.   Statement 154 requires that all voluntary changes in accounting principles and changes required by a new accounting pronouncement that do not include specific transition provisions be applied retrospectively to prior periods’ financial statements, unless it is impracticable to do so. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Our adoption of SFAS No. 154 did not have a significant effect on our consolidated financial statements.

 

In June 2006, the FASB issued FASB Interpretation No. 48 , Accounting for Uncertainty in Income Taxes  — an Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes , and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We are required to adopt the provisions of FIN 48 beginning in 2007. We are currently in the process of assessing what impact FIN 48 may have on our consolidated financial position, results of operations or cash flows.

 

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which states that registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating materiality of a misstatement. The interpretations in SAB No. 108 contain guidance on correcting errors under the dual approach as well as provide transition guidance for correcting errors. This interpretation does not change the requirements within SFAS No. 154 for the correction of an error in financial statements. SAB No. 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. We adopted this interpretation in the fourth quarter of 2006 and it did not have a material impact on our financial results.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157) . This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 in 2008 to have a material impact on our results of operations or financial position.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits entities to choose to measure at fair value some financial instruments and certain other items that are not currently required to be measured at fair value. Subsequent changes in fair value for designated items will be required to be reported in earnings in the current period. SFAS No. 159 also establishes presentation and disclosure requirements for similar types of assets and liabilities measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are currently assessing the effect of implementing this guidance, which directly depends on the nature and extent of eligible items elected to be measured at fair value, upon initial application of the standard on January 1, 2008.

 

Overview

 

We have developed, manufacture and sell the Hi Art system, an advanced and versatile radiation therapy system for the treatment of a wide variety of cancers. The Hi Art system precisely delivers radiation with sub-millimeter accuracy to kill cancer cells while reducing radiation exposure to surrounding healthy tissue, which we believe can lead to improved patient outcomes. The Hi Art system contains a linear accelerator, which is a device that generates external beam radiation that is used both to capture high quality, quantitative images and to deliver therapeutic radiation in a helical, or spiral, delivery pattern 360 degrees around the body. The linear accelerator rotates around a rigid circular frame, or ring gantry, that is housed in a protective closing. This integrated design contrasts with traditional radiation therapy systems, which utilize a single, rotating arm referred to as a “C-arm”, that can deliver radiation from only a limited number of angles. Generating CT images with traditional C-arm systems typically requires the addition of auxiliary devices that generally lack the quantitative imaging capabilities necessary to accurately image the location, size and shape and density of tumors and internal anatomy. The Hi Art system’s helical delivery pattern and imaging capabilities, combined with the system’s advanced treatment planning software and ability to precisely shape the beam delivering radiation, allow clinicians to locate and define the size, shape and density of tumors, maximize radiation delivered to diseased tissue, minimize radiation delivered to healthy tissue and measure the radiation dose actually received by the patient. We believe these capabilities allow the Hi Art system to deliver sophisticated radiation treatments with speed and precision.

 

The Hi Art system’s combination of technologies allows clinicians to make modifications to a patient’s cancer treatment plan as changes in the location, size, shape and density of tumors or in the patient’s internal anatomy are detected over the course of treatment. To deliver radiation therapy, the Hi Art system first optimizes a patient’s treatment plan by calculating the radiation dose pattern that maximizes the radiation dose to the tumor and minimizes exposure of healthy tissue. A quantitative CT image of the treatment area is taken to identify the location, size, shape and density of the tumor and is used to position the patient on the treatment couch. The optimized radiation dose is then delivered using a proprietary device called a multi-leaf collimator, or MLC, that consists of a series of tungsten leaves that open and close to modulates the shape of radiation beams produced by the linear accelerator as the patient passes horizontally through the ring gantry. The data acquired for the accurate positioning of the patient can also be used to compute the dose received by the patient. Data regarding the dose distribution is used by the clinician to evaluate and, if necessary, adjust the treatment plan in subsequent treatment sessions to address changes in patient anatomy, such as tumor shrinkage or weight loss, as well as any previous errors accumulated in treatment delivery and planning. We believe that the process of making iterative adjustments to a patient’s treatment plan, referred to as adaptive radiation therapy, should become a standard technique for the treatment of most cancer patients receiving radiation therapy. The Hi Art system has the ability to provide daily, quantitative imaging and to incorporate adaptive radiation therapy easily and efficiently into clinicians’ regular clinical workflow distinguishes the Hi Art system from other radiation therapy systems.

 

We market the Hi Art system to hospitals and cancer treatment centers in North America, Europe and Asia, and offer customer support services in each region. Since commercial introduction of the Hi Art system in 2003, we have experienced significant revenue growth and have invested extensively in our manufacturing capabilities, and customer service and support infrastructure. For the years ended December 31, 2005 and 2006, we had revenue of $75.8 million and $156.1 million, respectively, representing growth of 106%. For the years ended December 31, 2005 and 2006, we had net income of $0.2 million and $12.8 million, respectively. Net income for 2006 included a $7.8 million benefit from deferred income taxes and an expense of $3.1 million reflecting the fair value of outstanding warrants. As of December 31, 2006, we had an installed base of 108 Hi Art systems worldwide and had a backlog of $164 million, the significant majority of which we expect to deliver before the end of 2007.

 

Market Overview

 

According to the World Health Organization, in 2005 there were approximately 24.6 million people worldwide living with cancer and an estimated 7.6 million cancer deaths, accounting for 13% of all deaths worldwide. The World Health Organization estimates that approximately 10.9 million new cases of cancer are diagnosed globally each year. The instances of diagnosed cancer are expected to continue to rise as a result of increased life expectancy, aging populations and technological improvements, which are leading to more sophisticated screening techniques and earlier detection of cancer.

 

The three primary methods of treating cancer are radiation therapy, chemotherapy and surgery, each of which can be used alone or in combination, depending on the type of cancer being treated. Radiation therapy is a proven, effective and widely accepted form of treatment for many types of cancer. The National Cancer Institute estimates that nearly 50% of cancer patients in the United States are treated using radiation therapy. Currently, the most common type of radiation therapy is external beam radiation therapy, in which patients are treated with high-energy radiation generated by medical equipment external to the patient. Approximately 90% of patients treated with radiation therapy in the United States receive external beam radiation generated by a device called a linear accelerator. Linear accelerators have been widely used for radiation therapy for over 30 years. According to the August 2006 Radiation Therapy Equipment Report by Global Industry Analysts, Inc., there are over 7,500 linear accelerator-based radiation therapy systems in use for medical purposes worldwide. Linear accelerators represent the largest product segment by expenditure within the global radiation therapy equipment market, which totaled approximately $2.0 billion in 2006.

 

While radiation therapy is widely available in the United States and Western Europe, many developing countries currently do not have a sufficient number of linear accelerators to adequately treat their domestic cancer patient populations. For example, there are currently approximately 13 linear accelerators per million population in the United States compared to less than one per million population in India or China. We believe that increasing demand for advanced medical treatments in many international markets, growth in cancer cases worldwide and improvements in the sophistication of radiation therapy techniques will continue to drive demand for more advanced linear accelerators that integrate additional clinical functionality to make treatments more efficient and effective.

 

Radiation Treatment

 

Radiation energy is an effective method for killing cells and is used to treat various cancers. External beam radiation therapy works by exposing clusters of cancer cells, or tumors, to a dose of high energy radiation sufficient to alter their genetic structure, thereby causing cell death. When the radiation therapy process begins, the clinician targets radiation delivery to the tumor as precisely as possible in order to maximize the radiation dose delivered to cancerous tissue and minimize the exposure of healthy tissue. While the goal of radiation therapy is to selectively deliver radiation solely to cancer cells, radiation therapy can result in healthy tissue outside of the intended treatment area being exposed to significant doses of radiation. Damage to healthy tissue and structures can cause side effects ranging in severity from superficial burns, nausea and vomiting, to more serious side effects, such as damage to vital organs. Over time, the exposure of healthy tissue to radiation energy can result in accumulated damage to healthy tissue in the patient’s body and limit the patient’s future radiation therapy possibilities. In order to minimize such damage and exposure, clinicians divide the prescribed radiation dose into staged treatments, or fractions. Prescribed treatments typically consist of 25 to 35 fractions, and are administered over periods ranging from a few days to several weeks. Such fractions are intended to deliver a cumulative dose of radiation sufficient to kill cancer cells, while allowing healthy tissue to recover sufficiently between treatments.

 

Recent advances in radiation therapy technologies have focused on further improving the ability to target the radiation dose more precisely at cancer cells, while minimizing the exposure of healthy tissue. These advances include the following:

 

 

 

Despite advances in radiation therapy techniques, most commercially available radiation therapy systems still present significant limitations that restrict clinicians’ ability to provide the most effective treatment possible. These limitations include:

 

 

 

The TomoTherapy Solution

 

The Hi Art system is an advanced and versatile radiation therapy system for the treatment of a wide variety of cancers. We have designed the Hi Art system to offer clinicians and patients the following benefits: