IMPAC MEDICAL SYSTEMS INC - 10-Q Quarterly Report

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). x Yes ¨ No

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

The statements contained in this Form 10-Q that are not purely historical are forward looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding the Company’s expectations, beliefs, hopes, intentions or strategies regarding the future. Forward looking statements include statements regarding the Company’s business strategy, timing of, and plans for, the introduction of new products and enhancements, future sales, market growth and direction, competition, market share, revenue growth, operating margins and profitability. All forward looking statements included in this document are based upon information available to the Company as of the date hereof, and the Company assumes no obligation to update any such forward looking statement. Actual results could differ materially from the Company’s current expectations. Factors that could cause or contribute to such differences include the Company’s ability to expand outside the radiation oncology market or expand into international markets, our inability to recognize revenue from multiple element software contracts where certain elements have been delivered, installed and accepted but other elements remain undelivered, lost sales or lower sales prices due to competitive pressures, the ability to integrate its products successfully with related products and systems in the medical services industry, reliance on distributors and manufacturers of oncology equipment to market its products, changes in Medicare reimbursement policies, the integration and performance of acquired businesses, outstanding securities litigation and other factors and risks discussed in our Form 10-K for the fiscal year ended September 30, 2004 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Factors Affecting Financial Performance” and other reports filed by the Company from time to time with the Securities and Exchange Commission.

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying unaudited condensed consolidated financial statements of IMPAC Medical Systems, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month period ended December 31, 2004 are not necessarily indicative of the results that may be expected for the year ending September 30, 2005, or for any future period. The balance sheet at September 30, 2004 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These financial statements and notes should be read in conjunction with the financial statements and notes thereto for the year ended September 30, 2004 included in the Company’s Form 10-K for the fiscal year ended September 30, 2004 filed December 14, 2004.

The Company’s significant accounting policies are disclosed in the Company’s Form 10-K filed on December 14, 2004 for the year ended September 30, 2004.

Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. As of December 31, 2004 and September 30, 2004, inventories were comprised entirely of finished goods.

Goodwill and other intangible assets, including customer lists and acquired workforce, are stated at cost and are amortized on a straight-line basis over their estimated useful lives of generally two to five years. Effective October 1, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” which establishes financial accounting and reporting for acquired goodwill and other intangible assets and supersedes Accounting Principles Board Opinion No. 17 (“APB No. 17”), “Intangible Assets.” In accordance with SFAS No. 142, the Company has ceased amortizing goodwill and instead performs an assessment for impairment at least annually by applying a fair-value based test. The Company has also reclassified the unamortized balance of acquired workforce to goodwill. Accordingly, no goodwill or acquired workforce amortization was recognized during the three months ended December 31, 2003 and 2004. The annual goodwill impairment test was completed during the first quarter of fiscal 2005 and 2004, and did not result in any impairment of recorded goodwill.

The Company’s revenue is derived primarily from two sources: (i) software license revenue from sales to distributors and end users and (ii) maintenance and services revenue from providing software support, education and consulting services to end users. The Company typically requires deposits upon the receipt of a signed purchase and license agreement, which are classified as customer deposit liabilities on the Company’s consolidated balance sheet.

The Company accounts for sales of software and maintenance revenue under the provisions of Statement of Position 97-2, (“SOP 97-2”), “Software Revenue Recognition,” as amended. SOP 97-2 requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on vendor-specific objective evidence (“VSOE”) of the fair value of the delivered and/or undelivered elements. For hardware transactions where no software is involved, the Company applies the provisions of Staff Accounting Bulletin 104, “Revenue Recognition.”

The Company recognizes revenue from the sale of software licenses when persuasive evidence of an arrangement exists, the product has been accepted, the fee is fixed or determinable, and collection of the resulting receivable is probable. Acceptance generally occurs after the product has been installed, training has occurred and the product is in clinical use at the customer site. For distributor related transactions, acceptance occurs with delivery of software registration keys to the distributor’s order fulfillment department.

The fee for multiple element arrangements is allocated to each element of the arrangement, such as maintenance and support services, based on the relative fair values of the elements. The Company determines the fair value of each element in multiple element arrangements based on VSOE for each element, which is based on the price charged when the same element is sold separately. If VSOE of the fair value of all undelivered elements exists but VSOE of the fair value does not exist for one or more delivered elements, then 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. If VSOE of the fair value does not exist for all undelivered elements, revenue is deferred until VSOE of the fair value exists for all undelivered elements, the elements for which VSOE of the fair value does not exist have been delivered or the elements for which VSOE of the fair value does not exist (a) have been deleted from the contract or (b) there is competent evidence that allows for the reasonable judgment that it is remote that the customer will request delivery.

The first year of maintenance and support, which includes updates and support, for the Company’s software products is included in the purchase price. Upon revenue recognition, the Company defers 12% of the list price, which is the renewal rate, and recognizes that portion over the remaining term of the included maintenance and support period. Fair value of services, such as training or consulting, is based upon separate sales by the Company of these services to other customers. Payments received for maintenance and services are deferred and recognized as revenue ratably over the service term. Training and consulting services are billed based on hourly rates, and are generally recognized as revenue as these services are performed. Amounts deferred for installed and accepted software products under multiple element arrangements where VSOE of the fair value for all undelivered elements does not exist, maintenance services and term software license agreements comprise the main components of deferred revenue.

For direct software sales licensed on a term basis, the initial term lasts from three to five years with annual renewals after the initial term. The customer pays a deposit typically equal to the initial annual fee upon signing the license agreement, and the Company invoices the customer for subsequent annual fees 60 days before the anniversary date of the signed agreement. The Company recognizes revenue for the annual fees under these term license agreements ratably over the applicable twelve-month period. The annual fee includes maintenance and support.

The Company recognizes revenue from third-party products and related configuration and installation services sold with its licensed software upon acceptance by the customer. The Company recognizes revenue from third-party products sold separately from its licensed software upon delivery.

Due to the significant implementation and customization efforts essential to the functionality of the related products, the Company recognizes the license and

professional consulting services generated through the sale of pathology management information systems using the percentage-of-completion method using labor hours incurred as prescribed by SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts.” The progress toward completion is measured based on labor hours incurred as compared to total estimated hours to complete. The Company accounts for a change in estimate in the period the change was identified. Provisions for estimated contract losses are recognized in the period in which the loss becomes probable and can be reasonably estimated.

The Company has also entered into an application service provider agreement whereby the Company provides all software, equipment and support during the term of the agreement. Revenues are recognized ratably over the term of the agreement, generally 60 months. Under the terms of this agreement, the customers must pay for the final two months of the term up front. These deposits are classified as long-term customer deposit liabilities on the Company’s consolidated balance sheet.

The Company uses the intrinsic value method of APB Opinion No. 25 (“APB No. 25”), “Accounting for Stock Issued to Employees,” in accounting for its employee stock options, and presents disclosure of pro forma information required under Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123” (“SFAS No. 148”). No compensation expense is included in the net income as reported during the three months ended December 31, 2004 and 2003.

Had compensation costs been determined based upon the fair value at the grant date, consistent with the methodology prescribed under SFAS No. 123, the Company’s total stock-based compensation cost, pro forma net income (loss) and pro forma net income (loss) per common share, basic and diluted, would have been as follows (in thousands, except per share data):

The determination of fair value of all options granted after the Company’s initial public offering include an expected volatility factor in addition to the risk free interest rate, expected term and expected dividends.

Comprehensive income (loss) generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s unrealized gains and losses on available-for-sale securities and cumulative translation adjustments represent the components of comprehensive income (loss) that were excluded from the net income (loss). Total comprehensive income (loss) for the three months ended December 31, 2004 and 2003 is presented in the following table (in thousands):

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of vested common shares outstanding for the period. Diluted net income (loss) per common share is computed giving effect to all potentially dilutive common stock equivalents.

A reconciliation of the denominator used in basic and diluted net income (loss) per common share follows (in thousands).

At December 31, 2004 and 2003, options to purchase approximately 501,000 and 90,000 shares of common stock, respectively, were excluded from the computation of diluted net income (loss) per common share as their effect is antidilutive.

FASB Staff Position (“FSP”) No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (“FSP 109-2”), provides guidance under SFAS No. 109, Accounting for Income Taxes, with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Creation Act”) on enterprises’ income tax expense and deferred tax liability. The Jobs Creation Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Creation Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. The Company has not yet completed its evaluation on the impact of the repatriation provisions. Accordingly, as provided for in FSP 109-2, the Company has not adjusted its tax expense or deferred tax liability to reflect the repatriation provisions of the Jobs Creation Act.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges beginning in the Company’s fourth quarter of fiscal year 2005. The Company does not believe the adoption of SFAS No. 153 will have a material effect on its consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which replaced SFAS No. 123 and superseded APB 25. SFAS No. 123R addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under SFAS No. 123R, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB 25 but will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of earnings. SFAS No. 123R is effective beginning in the Company’s fourth quarter of fiscal year 2005 and allows, but does not require, companies to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS No. 123R. The Company has not yet determined which fair-value method and transitional provision it will follow. The impact on the Company’s consolidated financial statements of applying the Black-Scholes option valuation method of accounting for stock options is disclosed in the Accounting for Stock-Based Compensation section above.

The following table reflects the gross carrying amount and accumulated amortization of the Company’s intangible assets on the consolidated balance sheets as follows (in thousands):

Amortization expense for those intangible assets still required to be amortized under SFAS No. 142 was $581,000 and $120,000 and for the three months ended December 31, 2004 and 2003, respectively. The Company estimates amortization expense on a straight-line basis to be $1,744,000 for the remainder of fiscal 2005. For fiscal years 2006 through 2011, the Company estimates amortization expense of $1,797,000, $1,410,000, $1,410,000, $468,000, $141,000 and $28,000, respectively.

The Company leases its facilities and premises under noncancelable operating leases, which expire between October 2004 and March 2007. The leases in Mountain View, California and in Cambridge, Massachusetts have options to extend the leases for additional terms ranging from two to five years. Under these agreements, the Company is responsible for certain maintenance costs, taxes and insurance expenses. The Company also leases premises in various locations on a month to month basis.

In addition, the Company leases three automobiles and office equipment under operating leases with expiration dates through July 2007, each having purchase options at the end of the lease term. At December 31, 2004, aggregate future minimum payments under noncancelable operating leases are as follows (in thousands):

In July 2002, the Company entered into service agreements for telecommunications services through 2007. The services contracted for include wireless, frame-relay, voice/data and internet transport services. In September 2004, the Company entered into a distribution agreement with Advizor Solutions to provide third party analysis products. At December 31, 2004, total future minimum obligations under these agreements are as follows (in thousands):

During 2000, the Company acquired office furniture under a capital lease. Payments, comprising both principal and interest, were due in sixty equal monthly installments through March 2005. The Company paid the capital lease in full during fiscal year 2004.

In connection with the Tamtron/MRS acquisition in December 2003, the Company assumed several capital lease obligation liabilities. The Company paid all acquired capital leases off in full during fiscal year 2004.

The Company has contracted with third parties to supply data used in conjunction with the Company’s products. These contracts provide for payment of royalties ranging from 1.0% to 5.0% of future net sales from certain products.

The following three putative securities class actions that were filed after the Company’s March 1, 2004 announcement of its intent to restate its financial statements for fiscal years 2000 through 2003 have been voluntarily dismissed by the plaintiffs that filed the actions.

On September 8, 2004, an alleged shareholder of the Company filed a putative securities class action lawsuit in the United States District Court for the Northern District of California. See Operating Engineers Construction Industry and Miscellaneous Pension Fund (Local 66 — Pittsburgh), on Behalf of Itself and All Others Similarly Situated v. IMPAC Medical Systems, Inc., Joseph K. Jachinowski and Kendra A. Borrego (the “Operating Engineers action”). The lawsuit alleged, among other things, that during the period from November 20, 2002 to May 13, 2004 (the “class period”), the Company falsely reported its results for fiscal years 2000 to 2003 through improper revenue recognition, and thereby artificially inflated the price of the Company’s stock. The plaintiff purported to have brought this lawsuit as a class action on behalf of all persons who purchased the Company’s securities on the open market during the class period.

On September 14, 2004, two individuals filed a second purported securities class action lawsuit in the United States District Court for the Northern District of California that was substantively identical to the one filed on September 8, 2004. See Alan Lerner and Marvin Rogers, on Behalf of Themselves and All Others Similarly Situated v. IMPAC Medical Systems, Inc., Joseph K. Jachinowski and Kendra A. Borrego (the “Lerner action”). The second lawsuit alleged the same claims against the same defendants on behalf of the same purported class of shareholders (those who purchased the Company’s securities on the open market during the period from November 20, 2002 to May 13, 2004) as the earlier-filed lawsuit.

On September 21, 2004, another individual filed a third putative securities class action lawsuit in the United States District Court for the Northern District of California. See John Maras, Individually and On Behalf of All Others Similarly Situated v. IMPAC Medical Systems, Inc., Joseph Jachinowski, Kendra Borrego, David Auerbach, and James Hoey (the “Maras action”). This lawsuit alleged the same claims under the federal securities laws as the two earlier-filed lawsuits, and named as defendants, in addition to the Company and the two executives named in the two earlier-filed lawsuits, two other executive officers of the Company. This lawsuit alleged the same class period as the two earlier-filed actions (i.e., November 20, 2002 to May 13, 2004), and likewise alleged that during the class period the Company overstated its financial results for fiscal years 2000 to 2003 through improper revenue recognition, allegedly resulting in artificial inflation of the price of the Company’s stock during the class period. This action further alleged that each of the four individual defendants sold shares of the Company’s stock during the class period while in possession of material nonpublic information.

On January 11, 2005, the plaintiff in the Maras action filed a notice of voluntary dismissal of his complaint. In view of this notice of voluntary dismissal, the Court on January 12, 2005, entered an order directing the clerk of the court to close the case file and terminate all motions. On January 24, 2005, the plaintiff in the Operating Engineers action, and the plaintiffs in the Lerner action, filed a notice of voluntary dismissal of their respective complaints. On January 26, the Court entered an order in each of these cases directing the clerk to close the case file and terminate all motions.

The Company enters into standard indemnification arrangements in its ordinary course of business. Pursuant to these arrangements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified party, generally its business partners or customers, in connection with any trade secret, copyright, patent or other intellectual property infringement claim by any third party with respect to its products. The term of these indemnification agreements is generally perpetual anytime after the execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these agreements is not determinable. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated fair value of these agreements is minimal.

The Company has entered into indemnification agreements with its directors and officers that may require the Company: to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified; and to make good faith determination whether or not it is practicable for the Company to obtain directors’ and officers’ insurance. The Company currently has directors’ and officers’ insurance.

Elekta AB (“Elekta”) and the Company announced an agreement on January 18, 2005, under which Elekta will acquire the Company. The acquisition will enable Elekta, a world leading supplier of advanced clinical solutions for high precision radiation treatment of cancer and for non- or minimally invasive treatment of brain disorders, to offer customers a new, broad array of health care information products for clinical, administrative, outcomes and decision support purposes.

Under the terms of the agreement, Elekta will pay $24.00 in cash for each share of the Company’s common stock outstanding, which represents a premium of 22% over the Company’s closing price on January 14, 2005, and equates to a diluted equity value of approximately $250 million and an enterprise value of approximately $190 million. The merger is contingent upon approval of the transaction by the Company’s stockholders, receipt of Hart-Scott-Rodino regulatory approval and other customary closing conditions. The Company’s board of directors has approved the acquisition and recommends that stockholders vote in favor of the transaction. The Company intends to hold a special stockholders meeting to approve the merger in mid-April 2005 and to close the transaction shortly thereafter. Major stockholders of the Company, together holding approximately 33 percent of the Company’s shares, have entered into agreements with Elekta to vote their shares in favor of the transaction.

On January 21, 2005, an alleged holder of IMPAC common stock filed a purported class action lawsuit, “Stakely v. IMPAC Medical Systems, Inc., et al.” in California Superior Court for the County of Santa Clara. The complaint names as defendants IMPAC and each member of our board of directors. The complaint alleges that, in pursuing the merger with Elekta and approving the merger agreement, the directors violated their fiduciary duties to the holders of IMPAC common stock by, among other things, failing to implement a process designed to maximize stockholder value, engaging in self-dealing and securing benefits for certain officers and directors of IMPAC at the expense of the plaintiffs and other stockholders. The complaint seeks a preliminary and permanent injunction to enjoin the company from consummating the merger, as well as attorneys’ fees and other remedies.

Item 2. M anagement’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and the related notes appearing in our Form 10-K for the fiscal year ended September 30, 2004 filed December 14, 2004. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth elsewhere in this Form 10-Q.

We provide information technology systems for cancer care. Our systems provide electronic medical record, imaging, laboratory information management, decision support, scheduling and billing applications in an integrated platform to manage the complexities of cancer care, from detection and diagnosis through treatment and follow-up. We were founded in 1990, and our growth has been primarily organic, supplemented by several product and small company acquisitions.

Elekta AB (“Elekta”) and IMPAC Medical Systems, Inc. announced on January 18, 2005 an agreement under which Elekta will acquire IMPAC. The acquisition will enable Elekta, a world leading supplier of advanced clinical solutions for high precision radiation treatment of cancer and for non- or minimally invasive treatment of brain disorders, to offer customers a new, broad array of health care information products for clinical, administrative, outcomes and decision support purposes.

Under the terms of the agreement, Elekta will pay $24.00 in cash for each share of IMPAC common stock outstanding, which represents a premium of 22 percent over the IMPAC closing price on January 14, 2005, and equates to a diluted equity value of approximately $250 million and an enterprise value of approximately $190 million. The merger is contingent upon approval of the transaction by IMPAC’s stockholders, receipt of Hart-Scott-Rodino regulatory approval and other customary closing conditions. IMPAC’s board of directors has approved the acquisition and recommends that stockholders vote in favor of the transaction. IMPAC intends to hold a special stockholders meeting to approve the merger in mid-April and to close the transaction shortly thereafter. Major stockholders of IMPAC, together holding approximately 33 percent of the company’s shares, have entered into agreements with Elekta to vote their shares in favor of the transaction.

Although our revenues in fiscal 2004 increased over fiscal 2003, the growth rate in our core oncology point-of-care business, which constitutes the majority of our non-recurring revenue, slowed. We initially noted a softening of backlog in the first quarter of fiscal 2004, which, at the time, was within historical norms. However, bookings in our core business remained soft throughout 2004 and the softness continued in the first quarter of fiscal 2005. We believe several factors contributed to this softness.

First, on the radiation oncology front, all three linear accelerator manufacturers have introduced “next generation” devices which have new operator front-ends and require new integration strategies. This has created uncertainty in the marketplace as customers are not fully aware of the connectivity options and the device manufacturers have used it as a means to confuse the marketplace and bundle their proprietary solutions. We have begun testing our interfaces to the new devices in the first quarter of fiscal 2005 and will continue those activities throughout the next few months. Second, we are also facing increasing pressure from competitors who have bundled deals where the software component is being offered at significant discounts as we have seen price shifting from the software to the hardware components putting us at a pricing disadvantage. Third, the second quarter of fiscal 2004 also witnessed a consolidation of oncology software players with two independent medical oncology IT players being acquired by cancer related companies. Fourth, Medicare reimbursement policies also continue to damper oncology IT spending. Decreased reimbursements in the radiation oncology segment and anticipated reductions in the medical oncology segment led to delays in purchasing as facilities re-examine their budgets and return on investment expectations. Fifth, over the last several quarters our accounting restatements had an effect on bookings as some of our competitors used the event to sell against us. We completed our financial restatement in the first quarter of fiscal 2005. Finally, if our new installation backlog continues to contract, we will have less installation scheduling flexibility, which will expose our revenue stream to quarterly fluctuations if customers are not willing to take installation due to, for example, construction or equipment delays.

We sell our products directly throughout the world and primarily in North America, Europe and the Pacific Rim countries. In addition, we use non-exclusive distributors to augment our direct sales efforts. Sales through our primary distributor, Siemens Medical Systems, Inc., represented 10.2% of our total net sales in the three months ended December 31, 2004 and 7.1% for the same period in fiscal 2004. Distributor sales as a percentage of net sales have increased over the past year as their demand for information technology products has grown. We have signed agreements with other distributors, which have not yet generated sales. Revenues from the sale of our products and services outside the United States accounted for 7.4% of our net sales in the three months ended December 31, 2004 and 2.1% of our net sales for the same period in fiscal 2004. International sales as a percentage of net sales have increased over the past year as the demand of our information systems have grown due to our international expansion and international distributor sales have increased.

We license point-of-care and registry software products. Our point-of-care products are comprised of modules that process administrative, clinical, imaging and therapy delivery information. Our registry products aggregate data on patient outcomes for regulatory and corporate reporting purposes. Currently, a majority of our point-of-care software is licensed on a perpetual basis, and a majority of our registry sales are licensed on a term basis.

Our focus with regard to software licensing and maintenance and support service is to provide flexibility in the structure and pricing of our product offerings to meet the unique functional and financial needs of our customers. For those customers who license on a perpetual basis, we promote annual maintenance and support service agreements as an incremental investment designed to preserve the value of the customer’s initial investment. For those customers who license on a term basis, annual maintenance and support contributes greatly to the value of the annual license, and the two cannot be segregated from each other. For those customers using our application service provider option, independent of the licensing method, these annual fees allow the customer to outsource, in a cost effective manner, support and connectivity functions that are normally handled by internal resources.

The decision to implement, replace, expand or substantially modify an information system is a significant commitment for healthcare organizations. In addition, our systems typically require significant capital expenditures by the customer. Consequently, we experience long sales and implementation cycles. The sales cycle for our systems ranges from nine to twenty-four months or more from initial contact to contract execution. Our implementation cycle generally ranges from three to nine months from contract execution to completion of implementation. In addition to the core system, approximately one-third of our customers purchase additional product modules along with the core system that they intend to implement over a period of time greater than the typical implementation cycle of three to nine months.

We have experienced significant variations in revenues and operating results from quarter to quarter. Our quarterly operating results may continue to fluctuate due to a number of factors, including: the timing, size and complexity of our product sales and implementations; our inability to recognize revenue from multiple element software contracts where certain elements have been delivered, installed and accepted but other elements remain undelivered; construction delays at client centers which impact our ability to install products; the timing of installation of third party medical devices, including accelerators, simulation machines and imaging devices, at client sites, which must be installed before we can implement our systems; overall demand for healthcare information technology; and other factors discussed in our Form 10-K for the fiscal year ended September 30, 2004 filed December 14, 2004.

We record orders for products licensed on a perpetual basis upon the receipt of a signed purchase and license agreement, purchase order, and a substantial deposit. We record orders for products licensed on a term basis upon receipt of a signed purchase and license agreement, purchase order and a deposit typically equal to the first year’s fees. All contract deposits are held as a liability on the condensed consolidated balance sheet until products are delivered and accepted as outlined in the terms and conditions set forth in the purchase and license agreement. Maintenance and support is recorded as deferred revenue upon the invoice date and held as a current liability on the balance sheet. Under the terms of the original purchase and license agreement, maintenance and support automatically renews on an annual basis unless the customer provides a written cancellation. We recognize revenue from these sales ratably over the underlying maintenance period.

For direct software sales licensed on a perpetual basis, we include one year of maintenance and support as part of the purchase price. Standard annual fees for maintenance and support after the first year equal 12% of the then current list price unless the customer negotiates other terms or service levels.

Our sales arrangements with customers frequently cover multiple products and services. Our revenue is subject to SOP 97-2, as further discussed in Note 2 to our condensed consolidated financial statements. In approximately two-thirds of our arrangements, our customers request delivery and installation of our software products in one phase, and we generally can recognize revenue when the software products have been installed and accepted by our customers. In the balance of our arrangements, our customers request that delivery and installation of our software products be delivered in multiple phases. Such multiple phased installations may be requested, for example, when the customer has not installed medical devices with which our software will interact. In those instances, revenue for the entire arrangement generally cannot be recognized until the last software product is installed and accepted. In a few instances, the customer may never request delivery of all the software products included in the arrangement. In those instances, revenue from the arrangement is recognized at the time we make the judgment, based on sufficient competent evidence, that it is remote that the customer will request delivery of the remaining undelivered software products, i.e., when they have been constructively cancelled.

We recognize revenue once software products outlined in the related purchase and license agreement have been installed, accepted and in clinical use at the customer site. When a customer accepts only a subset of the products outlined in a multiple element purchase and license agreement and we have not established vendor specific objective evidence, or VSOE, of the fair value of the undelivered elements, we invoice the customer for the accepted products and record the transaction as deferred software license revenue. We recognize the deferred revenue when all elements in a multiple element arrangement are accepted, VSOE of the fair value is established on the remaining undelivered elements, or the undelivered elements for which VSOE of the fair value does not exist have been formally or constructively canceled, whichever occurs first. We recognize revenues on sales arrangements with undelivered products that have been constructively canceled at the date when we have sufficient competent evidence of that cancellation.

The first year of maintenance and support for our software products is included in the purchase price. Upon revenue recognition, we defer 12% of the list price, which is the renewal rate, and recognize that portion over the remaining term of the included maintenance and support period. For example, if revenue recognition occurs four months subsequent to product acceptance, we would recognize one third of the 12% maintenance and support deferral as revenue and recognize the remaining two thirds of the deferral over the following eight months. In situations where the first phase of software products are installed greater than one year prior to our ability to recognize the related revenue, it is not necessary to defer 12% of the list price and recognize that portion over the included maintenance and support period as the first year maintenance and support obligation is no longer applicable. In these cases, 12% of the license purchase price is classified as maintenance and services revenue at the time of revenue recognition.

For direct software sales licensed on a term basis, the initial term lasts from three to five years with annual renewals after the initial term. The customer pays a deposit typically equal to the initial annual fee upon signing the license agreement, and we invoice the customer for subsequent annual fees 60 days before the anniversary date of the signed agreement. We recognize revenue for the annual fees under these term license agreements ratably over the applicable twelve-month period. The purchase price includes annual maintenance and support.

We recognize revenue from third-party products and related configuration and installation services sold with our licensed software upon acceptance by the customer. We recognize revenue from third-party products sold separately from our licensed software upon delivery. Third-party products represented 3.0% of our total net sales in the three months ended December 31, 2004 and 4.3% for the same period in fiscal 2004. The decrease in third-party sales as a percentage of net sales is attributable to a lower growth rate in our third-party product sales.

We recognize distributor related revenues upon the receipt of a completed purchase order and the related customer information needed to generate software registration keys, which allows the distributor to deploy the software to the end user and satisfy our regulatory information tracking requirements. We provide maintenance and support to our distributor. The cost of the first year’s support is included in the fee. Renewal support is purchased for 5% of the transfer price for software licenses sold to their customers. We defer the distributor’s first year post-contract support, based on the renewal rate, and recognize that portion of the revenue ratably over the support period. We invoice maintenance and support annually at the beginning of each fiscal year and recognize revenue ratably over the applicable twelve-month period.

Due to the significant implementation and customization efforts essential to the functionality of the related products, we recognize the license and professional consulting services generated through the sale of pathology management information systems using the percentage-of-completion method using labor hours incurred as prescribed by SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Product-Type Contracts.” The progress toward completion is measured based on labor hours incurred as compared to total estimated hours to complete. We account for a change in estimate in the period the change was identified. Provisions for estimated contract losses are recognized in the period in which the loss becomes probable and can be reasonably estimated.

A large part of our company cost structure is driven by the number of employees and related benefit and facility costs. As a result, a significant amount of strategic and fiscal planning is focused on this area, so we can develop internal resources at a controlled and sustainable rate. Since revenue recognition happens subsequent to all implementation and training activities, we incur the costs of labor, travel and some third-party product expenses in advance.

System installations require several phases of implementation in the process of accepting product delivery and have led to our development of a highly specialized client service organization. All new orders require multiple site visits from our personnel to properly install, configure and train customer personnel. In transactions where we are required to defer the recognition of software license revenue, the associated incremental direct travel expenses are recorded as a prepaid expense until the associated revenue is recognized. Several point-of-care products are used with various third-party hardware and software products that are also sold and configured during the implementation process. After the initial implementation process, our application support staff provides phone support and any applicable system updates. A substantial percentage of engineering costs are allocated to client services due to continuing engineering efforts related to the support and enhancement of our products. Historically, cost of sales has increased at approximately the same rate as net sales. However, as newly developed products and acquired product lines are released to the customers, additional investments in client service staff could cause gross margins to fluctuate.

Research and development expenses include costs associated with the design, development and testing of our products. These costs consist primarily of:

We currently expense all research and development costs as incurred. Our research and development efforts are periodically subject to significant non-recurring costs that can cause fluctuations in our quarterly research and development expense trends. We expect that research and development expenses will increase in absolute dollars for the foreseeable future as we continue to invest in product development.

We have recently expanded our sales force, made significant investments in marketing communications and increased trade show activities to enhance market awareness of our products. We expect that sales and marketing expenses will increase in absolute dollars for the foreseeable future as we continue to expand our sales and marketing capabilities. In transactions where we are required to defer the recognition of software license revenue, the associated incremental direct commission expense is recorded as a prepaid expense until the associated revenue is recognized.

A significant portion of facility, infrastructure and maintenance costs are allocated as overhead to other functions based on distribution of headcount. We expect that our general and administrative expenses will increase if we continue as a public company.

Our property and equipment is recorded at our cost minus accumulated depreciation and amortization. We depreciate the costs of our tangible capital assets on a straight-line basis over the estimated economic life of the asset, which is generally three to seven years. Acquisition related intangible assets have historically been amortized based upon the estimated economic life, which is generally two to nine years. Leasehold improvements and equipment purchased through a capital lease are amortized over the life of the related asset or the lease term, if shorter. If we sell or retire an asset, the cost and accumulated depreciation is removed from the balance sheet and the appropriate gain or loss is recorded. We expense repair and maintenance costs as incurred.

The following table sets forth certain operating data as a percentage of net sales for the periods indicated:

Net Sales. Net sales increased 12.7% to $17.4 million in the three months ended December 31, 2004 from $15.4 million for the same period in fiscal 2004 including $3.3 million related to the acquisition of certain assets and certain liabilities of Tamtron Corporation (“Tamtron”) and Medical Registry Services, Inc. (“MRS”), the PowerPath^{^®} pathology information management and cancer registry information system businesses of IMPATH Inc.

Net software sales decreased 4.2% to $8.8 million in the three months ended December 31, 2004 from $9.2 million for the same period in fiscal 2004. The decline is a result of decreased sales of new systems in oncology of $1.9 million, decreased sales of additional products to existing customers of $564,000 and imaging systems of $332,000, partially offset by increased sales of registry systems of $1.3 million and pathology lab systems of $1.1 million. We deferred a net $2.3 million of software license revenue in the three months ended December 31, 2004 as compared to $162,000 for the same period in fiscal 2004.

Maintenance and services sales increased 37.8% to $8.6 million for the three months ended December 31, 2004 from $6.2 million for the same period in fiscal 2004. Maintenance and support contracts accounted for $2.2 million of the total $2.4 million increase with the remaining portion attributed to increased non-contract training and support. The acquired pathology line of business contributed $891,000 of the total increase in maintenance and services. Our continued high customer retention on maintenance and support contracts, general price increases, deferral of installed and accepted software license revenue, and expansion of our service offerings all contributed to the growth of maintenance and services as a percentage of net sales.

Cost of Sales. Total cost of sales increased 31.1% to $6.9 million for the three months ended December 31, 2004 from $5.3 million for the same period in fiscal 2004. Our gross margin decreased to 60.3% for the three months ended December 31, 2004 from 65.9% for the same period in fiscal 2004.

Cost of sales relating to net software sales increased 39.4% to $4.2 million for the three months ended December 31, 2004 from $3.0 million for the same period in fiscal 2004. Our gross margin associated with net software sales decreased to 52.9% for the three months ended December 31, 2004 compared to 67.6% for the same period in fiscal 2004. The increase in expenses was related to $772,000 in employee costs for additional and acquired employees, $303,000 in supplies and materials, $67,000 in travel costs, $18,000 in implementation costs and $18,000 in telecommunication costs. The decline in the gross margin associated with net software sales related to fewer than projected implementations of new oncology systems as a result of flat order volume and a higher percentage of revenue deferrals compared to the same period in fiscal 2004.

Cost of sales relating to maintenance and services increased 6.7% to $2.4 million for the three months ended December 31, 2004 from $2.2 million for the same period in fiscal 2004. Our gross margin associated with maintenance and services increased to 72.5% for the three months ended December 31, 2004 from 64.5% for the same period in fiscal 2004. The increase in expenses of $147,000 was primarily related to increased employee related expenses. An increase in net sales of maintenance and services due to continued customer post-contract support renewals and revenue of the acquired product lines for the three months ended December 31, 2004 contributed to the improvement in our gross margin associated with maintenance and services.

In addition, due to the acquisition of MRS and Tamtron, amortization expense associated with purchased technology increased to $382,000 for the three months ended December 31, 2004 from $69,000 for the same period in fiscal 2004.

Research and Development. Research and development expenses increased 37.6% to $3.3 million for the three months ended December 31, 2004 from $2.4 million for the same period in fiscal 2004. As a percentage of total net sales, research and development expenses increased to 19.2% for the three months ended December 31, 2004

from 15.8% for the same period in fiscal 2004. Additional engineering headcount and the associated personnel expenses accounted for $891,000 and travel expenses accounted for $18,000 of the total increase in expenses. The increase as a percentage of total net sales in the three months ended December 31, 2004 was primarily due to increased engineering headcount associated with the acquired product lines in December 2003 and lower net sales.

Sales and Marketing. Sales and marketing expenses increased 27.7% to $5.2 million for the three months ended December 31, 2004 from $4.1 million for the same period in fiscal 2004. As a percentage of total net sales, sales and marketing expenses increased to 29.8% for the three months ended December 31, 2004 from 26.3% for the same period in fiscal 2004. The increase in expenses in absolute dollars related to $930,000 in employee related expenses, $309,000 in travel expenses, $99,000 in outside services, $56,000 in supplies and materials and $36,000 in telecommunication costs partially offset by a reduction in commissions of $236,000, sponsorships of $44,000 and advertising of $22,000. The increase as a percentage of total net sales in the three months ended December 31, 2004 was primarily due to the expansion and specialization of our domestic and international sales force and lower net sales.

General and Administrative. General and administrative expenses increased 92.8% to $2.2 million for the three months ended December 31, 2004 from $1.1 million for the same period in fiscal 2004. As a percentage of total net sales, general and administrative expenses increased to 12.5% for the three months ended December 31, 2004 from 7.3% for the same period in fiscal 2004. The increase in absolute dollars and as a percentage of total net sales in the three months ended December 31, 2004 was primarily due to increases in accounting and legal fees of $658,000 primarily related to our annual audit, restatement of our financial statements and negotiation of the proposed merger with Elekta, business insurance premiums of $133,000 for our directors and officers insurance renewal, outside services of $63,000, regulatory expenses of $46,000, employee related expense of $45,000, rent expense of $39,000 and other various net operational expenses of $52,000.

Amortization of Intangible Assets. Amortization expense increased to $199,000 for the three months ended December 31, 2004 from $51,000 for the same period in fiscal 2004. Our acquisition of substantially all of the assets of Tamtron and MRS in December 2003 increased amortization expense as it relates to customer base and trade name.

In-Process Research and Development. During the three months ended December 31, 2004, we did not have any transactions that required an in-process research and development write-off. During the three months ended December 31, 2003, we recorded a write-off of in-process research and development in the amount of $557,000 due to an analysis allocating the purchase price paid for certain intellectual property in that period. Both Tamtron and MRS were in the process of adding new functionality to their lines of software products and we believed there was sufficient risk in completing the technology to qualify the in-process research and development write-off.

Operating Income (Loss). Operating loss was $396,000 for the three months ended December 31, 2004 compared to operating income of $2.0 million for the same period in fiscal 2004. Operating income decreased significantly due to fewer than projected implementations of new oncology systems as a result of flat order volume, higher amortization of intangible assets related to the December 2003 asset purchases and additional fees associated with the annual audit, restatement of our financial statements and merger related expenses.

Interest and Other Income (Expense), Net. Interest and other income, net increased 132.4% to $337,000 for the three months ended December 31, 2004 from $145,000 for the same period in fiscal 2004. The increase was primarily related to a $148,000 settlement we received from a stockholder that had engaged in an inadvertent Section 16 matching transaction in our stock. The remaining increase was related to the investment of excess operating cash in available-for-sale securities and improved interest rates compared to the same period in fiscal 2004.

Income Taxes. Our effective tax rate increased to 34.0% during the three months ended December 31, 2004 from 33.0% during the same period in fiscal 2004 due to a reduction of research and development tax credits.

Our backlog is comprised of customer deposits, deferred software license revenue, other deferred revenue and unearned revenue. Customer deposits represent required deposits paid by our customers when they place orders. These deposits are held as a liability until revenue is recognized. Deferred software license revenue represents the revenues on installed, accepted and invoiced products that we cannot yet recognize because the products installed were only a subset of the products outlined in a multiple element arrangement for which we do not have VSOE of the fair value on all of the undelivered elements. If VSOE of the fair value of all undelivered elements exists but VSOE of the fair value does not exist for one or more delivered elements, then 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. If VSOE of the fair value does not exist for all undelivered elements, revenue is deferred until VSOE of the fair value exists for all undelivered elements, the elements for which VSOE of the fair value does not exist have been delivered or the elements for which VSOE of the fair value does not exist (a) have been deleted from the contract or (b) there is available competent evidence that allows for the reasonable judgment that it is remote that the customer will request delivery. Other deferred revenue represents maintenance and support services and term licenses which are generally recognized ratably over the support period and license term, respectively. Unearned revenue represents the value of products ordered but not installed or accepted in excess of the contract deposit. Orders are recognized only once we have received a signed purchase and license agreement, an authorized purchase order and a deposit check. Therefore, amounts in our sales pipeline that have not met all three order recognition criteria are not included in our backlog.

The components of backlog as of December 31, 2004 and 2003 and September 30, 2004 are as follows (amounts in thousands):

Total backlog increased 26.7% to $87.5 million at December 31, 2004 from $69.0 million at December 31, 2003, and total backlog increased 4.9%, or $4.1 million, from $83.4 million at September 30, 2004. During the three months ended December 31, 2004, bookings in our domestic core oncology point-of-care business were flat. We initially noted a softening of backlog in the three months ended December 31, 2003; however, at that time the amount was within historical norms and we expected our typical second quarter upswing. Bookings remained soft during the balance of fiscal 2004, and they continued that trend in the three months ended December 31, 2004. Of the total $87.5 million of backlog at December 31, 2004, we expect to recognize approximately $82.7 million of our backlog during the twelve months following December 31, 2004 with the remaining portion to be completed in subsequent periods. However, we cannot assure you that contracts included in backlog will generate the specified revenues or that these revenues will be fully recognized within the specified time periods.

Deferred revenue increased $13.4 million to $45.5 million at December 31, 2004 from $32.1 million at December 31, 2003. Of the $13.4 million increase, deferred oncology software license revenue and the related deferred maintenance and support contributed $5.6 million. The remaining $7.8 million increase relates to other deferred revenue of $4.7 million in post contract maintenance and support for oncology products, $1.4 million of pathology license revenue, $977,000 in registry term licenses and $717,000 in post-contract maintenance and support for pathology products.

Historically, we have experienced a seasonal pattern in our revenues, with our first quarter typically having the lowest revenues followed by increasing revenue growth in the subsequent quarters of our fiscal year. We believe the seasonality of our revenue is influenced by the year end of many of our customers’ budgetary cycles. As much of the labor and indirect expense associated with software systems for which revenue has been deferred are not matched with the subsequent revenue recognition, net income does not display a clear and predictable seasonal pattern.

In addition, the implementation of a significant contract previously included in backlog, or a contract intended to be installed in a phased manner over a longer than average time period, could generate a large increase in revenue and net income for any given quarter or fiscal year, which may prove unusual when compared to changes in revenue and net income in other periods. Furthermore, we typically experience long sales cycles for new customers, which may extend over several quarters before a sale is consummated and a customer implementation occurs. As a result, we believe that quarterly results of operations will continue to fluctuate and that quarterly results may not be indicative of future periods. The timing of revenues is influenced by a number of factors, including the timing of individual orders, customer implementations and seasonal customer buying patterns.

We have financed our operations since inception primarily through cash from operating activities, a $4.0 million private placement of equity in 1996, net proceeds of $24.4 million from our initial public offering of common stock in November 2002 and net proceeds of $3.2 million from our secondary public offering of common stock in May 2003. Cash, cash equivalents and available-for-sale securities were $59.5 million at December 31, 2004 compared to $45.6 million at December 31, 2003.

During the three months ended December 31, 2004, net cash provided by operating activities was $1.8 million compared to $339,000 of net cash used in operating activities for the same period in fiscal 2004. In the three months ended December 31, 2004, cash provided by operations was primarily attributable to net income (loss) after adjustment for the non-cash charges relating to depreciation and amortization, an increase in deferred revenue, an increase in accounts payable and a decrease in unbilled accounts receivable partially offset by increases in accounts receivable, prepaid expenses and other current assets and a decrease in accrued liabilities, income taxes payable and customer deposits. Cash used in operations during the three months ended December 31, 2003 was primarily attributable to an increase in deferred income taxes and accounts receivable and a decrease in accrued liabilities. These uses of cash were partially offset by net income after non-cash adjustments for depreciation and amortization and the $557,000 write-off of acquired in-process research and development and an increase in deferred revenue. As discussed in the Backlog section, bookings in our core oncology point-of-care business have unexpectedly flattened over the last year. As a result, the subsequent impact of flattened orders may effect the historical trend of operating cash in subsequent quarters.

In determining average days’ sales outstanding and accounts receivable turnover, we use our gross annual invoicing and gross accounts receivable balances in each calculation as we believe this provides a more conservative and relevant measurement basis due to the significance of our deferred revenue. Our accounts receivable turnover decreased to 4.0 for the three months ended December 31, 2004 from 4.2 for the same period in fiscal 2004. Our days’ sales outstanding at December 31, 2004 increased to 88 from 86 at December 31, 2003. We have added collections personnel during the last quarter, and we continue our efforts to improve collections by formalizing escalation procedures and improving internal communications. Revenue is only recognized when all of the criteria for revenue recognition have been met which is upon acceptance and invoicing of the final balance of the fee unless the invoice has payment terms extending longer than 60 days. Any invoice that has payment terms longer than 60 days is considered to have extended payment terms and is not recognized as a receivable or revenue until it is due and payable.

Net cash used in investing activities was $4.2 million for the three months ended December 31, 2004 and $22.4 million for the same period in fiscal 2004. During the three months ended December 31, 2004, cash used in investing activities related to the purchase of available-for-sales securities of $3.6 million with excess operating cash and the acquisition of $551,000 of capital equipment. During the three months ended December 31, 2003, cash used in investing activities primarily related to the Tamtron/MRS acquisition. Total cash outlays for this acquisition amounted to approximately $22.4 million, including acquisition costs.

Net cash provided by financing activities was $72,000 for the three months ended December 31, 2004, compared to $1.0 million for the same period in fiscal 2004. Cash provided by financing activities during the three months ended December 31, 2004 and 2003 can be attributed primarily to the issuance of common stock.

The following table describes our commitments to settle contractual obligations in cash not recorded on the balance sheet as of December 31, 2004 (in thousands). The telecommunications contracts with AT&T and others include wireless, frame-relay, voice/data and internet transport services.

We expect to increase capital expenditures consistent with our anticipated growth in infrastructure and personnel. We also may increase our capital expenditures as we expand our product lines or invest in new markets. We believe that available funds and cash generated from operations will be sufficient to meet our operating requirements, assuming no change in the operations of our business, for at least the next 18 months.

FASB Staff Position (“FSP”) No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (“FSP 109-2”), provides guidance under SFAS No. 109, Accounting for Income Taxes, with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Creation Act”) on enterprises’ income tax expense and deferred tax liability. The Jobs Creation Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Creation Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. We have not yet completed our evaluation on the impact of the repatriation provisions. Accordingly, as provided for in FSP 109-2, we have not adjusted our tax expense or deferred tax liability to reflect the repatriation provisions of the Jobs Creation Act.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges beginning in our fourth quarter of fiscal year 2005. We do not believe the adoption of SFAS No. 153 will have a material effect on our consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which replaced SFAS No. 123 and superseded APB 25. SFAS No. 123R addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. Under SFAS No. 123R, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB 25 but will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of earnings. SFAS No. 123R is effective beginning in the Company’s fourth quarter of fiscal year 2005 and allows, but does not require, companies to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS No. 123R. We have not yet determined which fair-value method and transitional provision we will follow. The impact on our consolidated financial statements of applying the Black-Scholes option valuation method of accounting for stock options is disclosed in the Accounting for Stock-Based Compensation section in Note 2 of the notes to the condensed consolidated financial statements.

This Form 10-Q contains forward-looking statements that involve risks and uncertainties, including statements relating to Elekta’s proposed acquisition of IMPAC. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of factors both in and out of our control, including the risks faced by us described below and elsewhere in this Form 10-Q and in our Form 10-K for the fiscal year ended September 30, 2004. Potential risks and uncertainties regarding the acquisition include, among others, the requirement that IMPAC’s stockholders must approve the transaction, the required receipt of necessary regulatory approvals, including from the SEC and under applicable antitrust laws, other conditions to the closing of the merger, the possibility that the transaction will not close or that the closing may be delayed, and the effect of the announcement of the merger on IMPAC’s customer relationships, operating results and business generally, including the ability to retain key employees.

You should carefully consider the risks described in this Form 10-Q and in our Form 10-K for the fiscal year ended September 30, 2004. In addition, these risks are not the only ones facing us. We have only described the risks we consider to be the most material. However, there may be additional risks that are viewed by us as not material or are not presently known to us.

If any of the events described below were to occur, our business, prospects, financial condition and/or results of operations could be materially adversely affected. When we say below that something could or will have a material adverse effect on us, we mean that it could or will have one or more of these effects. In any such case, the price of our common stock could decline, and you could lose all or part of your investment in our company.

The following discusses our exposure to market risk related to changes in interest rates and foreign currency exchange rates. These exposures may change over time as business practices evolve and could have a material adverse impact on our financial results.

We have been exposed to interest rate risk as it applies to our limited use of debt instruments and interest earned on holdings of long and short-term marketable securities. Interest rates that may affect these items in the future will depend on market conditions and may differ from the rates we have experienced in the past. A 10% change in interest rates would not be material to our consolidated results of operations. We reduce the sensitivity of our results of operations to these risks by maintaining an investment portfolio, which is primarily comprised of highly rated, short-term investments. We do not hold or issue derivative, derivative commodity instruments or other financial instruments for trading purposes.

We have operated mainly in the United States and greater than 99% of our sales were made in U.S. dollars in each of the three months ended December 31, 2004 and 2003. Accordingly, we have not had any material exposure to foreign currency rate fluctuations. Currently, all of our international distributors denominate all transactions in U.S. dollars. However, as we sell to customers in the United Kingdom and Europe through our recently formed UK subsidiary a majority of those sales may be denominated in euros or pounds sterling. The functional currency of our new UK subsidiary is pounds sterling. Thus, exchange rate fluctuations between the euro and pounds sterling will be recognized in the statements of operations as these foreign denominated sales are remeasured by our UK subsidiary. As exchange rate fluctuations occur between pounds sterling and the U.S. dollar, these fluctuations will be recorded as cumulative translation adjustments within stockholders’ equity as a component of accumulated other comprehensive income (loss) as our UK subsidiary is translated into U.S. dollars for consolidation purposes.

Joseph Jachinowski, our Chief Executive Officer, and Kendra Borrego, our Chief Financial Officer, conducted an evaluation of the effectiveness of IMPAC’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of December 31, 2004. Based on their evaluation, they each found the Company’s disclosure controls and procedures were adequate to ensure that information required to be disclosed in the reports that IMPAC files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required, and that information required to be disclosed is accumulated and communicated to them as appropriate to allow timely decisions regarding required disclosure, except as set forth below.

During the April 2004 restatement, our independent auditors at the time, PricewaterhouseCoopers LLP, advised management and the Audit Committee that it noted certain matters regarding software revenue recognition practices during the periods under review that it considered to be material weaknesses. As part of the initial restatement, we conducted an extensive internal review of our revenue recognition practices for all periods for which financial statements are included in this report. Among other things, this involved the review of each of the over 1,500 customer contracts entered into since October 1, 1999.

As part of our disclosure controls and procedures over the selection and application of accounting principles, in particular software revenue recognition under SOP 97-2, our accounting officers independently reviewed SOP 97-2 together with other accounting literature, consulted with our independent auditing firm regarding revenue recognition and accounting developments, attended continuing education courses for the accounting profession and reviewed various accounting journals and other literature with respect to the existence of new accounting pronouncements and their application to IMPAC.

These controls and procedures were found to be deficient in identifying the accounting issues which were the subject of the two restatements. Specifically, the controls and procedures did not result in (i) our proper understanding of the application of SOP 97-2 for multiple element contracts, (ii) the identification of an improper usage of a retroactive acceptance clause resulting in revenue being recognized in the incorrect period and (iii) the deferral of 12% of the current list price of the software rather than 12% of the net purchase price.

In response to the matters identified, we have taken steps to strengthen control processes and procedures to identify, rectify and prevent the recurrence of the circumstances that resulted in our determination to restate prior period financial statements. In addition to the changes in internal control listed below, we intend to correct the identified weaknesses in our disclosure controls and procedures that led to the restatement by taking the following steps, among others:

We believe changes to our system of internal controls and our disclosure controls and procedures will be adequate to provide reasonable assurance that the objectives of these control systems will be met. However, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.

Purported Shareholder Class Action Lawsuits Relating to Restatement Announcement

The following three putative securities class actions that were filed after the Company’s March 1, 2004, announcement of its intent to restate its financial statements for fiscal years 2000 through 2003 have been voluntarily dismissed by the plaintiffs that filed the actions.

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized.

IMPAC MEDICAL SYSTEMS, INC.

Registrant

Dated: February 9, 2005

/s/ JOSEPH K. JACHINOWSKI

Joseph K. Jachinowski

Chairman of the Board, President and

Chief Executive Officer

/s/ KENDRA A. BORREGO

Kendra A. Borrego

Chief Financial Officer




		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)	1

	Condensed Consolidated Balance Sheets as of December 31, 2004 and September 30, 2004	1

	Condensed Consolidated Statements of Operations for the Three Months Ended December 31, 2004 and 2003	2

	Condensed Consolidated Statements of Cash Flows for the Three Months Ended December 31, 2004 and 2003	3

	Notes to Condensed Consolidated Financial Statements	4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	15

Item 4.	Controls and Procedures	15

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	17

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	17

Item 3.	Defaults Upon Senior Securities	17

Item 4.	Submission of Matters to a Vote of Security Holders	17

Item 5.	Other Information	17

Item 6.	Exhibits	17

Signatures		19


	December 31, 2004			September 30, 2004
(In thousands)
Assets
Current assets:
Cash and cash equivalents	$	52,227		$	54,605
Available-for-sale securities		1,115			115
Accounts receivable, net		18,999			16,850
Unbilled accounts receivable		645			696
Inventories		105			115
Deferred income taxes, net		7,630			7,630
Prepaid expenses and other current assets		5,195			4,879

Total current assets		85,916			84,890
Available-for-sale securities		6,163			3,574
Property and equipment, net		4,362			4,367
Deferred income taxes		1,247			1,247
Goodwill		15,509			15,509
Other intangible assets, net		7,111			7,692
Other assets		491			481

Total assets	$	120,799		$	117,760

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	475		$	334
Accrued liabilities		3,682			4,128
Income taxes payable		2,485			3,082
Deferred revenue		45,385			41,023
Customer deposits, current		10,214			10,655

Total current liabilities		62,241			59,222
Customer deposits, net of current portion		302			302
Deferred revenue, net of current portion		78			74

Total liabilities		62,621			59,598

Stockholders’ equity:
Preferred stock		—			—
Common stock		10			10
Additional paid-in capital		50,503			50,431
Accumulated other comprehensive loss		(36	)		(19	)
Retained earnings		7,701			7,740

Total stockholders’ equity		58,178			58,162

Total liabilities and stockholders’ equity	$	120,799		$	117,760


	Three Months Ended December 31,
	2004			2003
(In thousands, except per share data)
Net sales:
Software license and other, net	$	8,842		$	9,225
Maintenance and services		8,556			6,207

Total net sales		17,398			15,432

Cost of sales:
Software license and other, net		4,168			2,991
Maintenance and services		2,350			2,203
Amortization of purchased technology		382			69

Total cost of sales		6,900			5,263

Gross profit		10,498			10,169

Operating expenses:
Research and development		3,344			2,431
Sales and marketing		5,176			4,052
General and administrative		2,175			1,128
Amortization of intangible assets		199			51
Write-off of purchased in-process research and development		—			557

Total operating expenses		10,894			8,219

Operating income (loss)		(396	)		1,950
Interest expense		—			(3	)
Interest and other income		337			148

Income (loss) before benefit (provision) from income taxes		(59	)		2,095
Benefit (provision) from income taxes		20			(691	)

Net income (loss)	$	(39	)	$	1,404

Net income (loss) per common share:
Basic	$	(0.00	)	$	0.14

Diluted	$	(0.00	)	$	0.14

Weighted-average shares used in computing net income (loss) per common share:
Basic		9,933			9,758

Diluted		9,933			10,240


	Three Months Ended December 31,
	2004			2003
(In thousands)
Cash flows from operating activities:
Net income (loss)	$	(39	)	$	1,404
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization of property and equipment		556			438
Amortization of intangible assets		581			120
Accretion of available-for-sale securities		30			34
Write-off of purchased in-process research and development		—			557
Provision for doubtful accounts		25			32
Deferred income taxes		—			(343	)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable		(2,174	)		(1,391	)
Unbilled accounts receivable		52			—
Inventories		9			(3	)
Prepaid expenses and other current assets		(316	)		(117	)
Other assets		(11	)		37
Customer deposits		(441	)		(221	)
Accounts payable		137			(544	)
Accrued liabilities		(440	)		(1,810	)
Income tax payable/refund receivable		(595	)		503
Deferred revenue		4,382			965

Net cash provided by (used in) operating activities		1,756			(339	)

Cash flows from investing activities:
Acquisition of property and equipment		(551	)		(372	)
Payments for the acquisition of Tamtron and MRS product lines		—			(22,430	)
Purchases of available-for-sale securities		(3,634	)		(1,076	)
Proceeds from maturities of available-for-sale securities		—			1,450

Net cash used in investing activities		(4,185	)		(22,428	)

Cash flows from financing activities:
Principal payments on capital leases		—			(18	)
Proceeds from the issuance of common stock, net		72			1,019

Net cash provided by financing activities		72			1,001

Net decrease in cash and cash equivalents		(2,357	)		(21,766	)
Effect of exchange rates on cash		(21	)		7
Cash and cash equivalents at beginning of period		54,605			57,979


Cash and cash equivalents at end of period	$	52,227		$	36,220


	Three Months Ended December 31,
	2004			2003
Net income (loss) as reported	$	(39	)	$	1,404
Less stock-based compensation cost under a fair value method		(200	)		(274	)

Pro forma net income (loss)	$	(239	)	$	1,130

Net income (loss) per common share, basic
As reported	$	(0.00	)	$	0.14

Pro forma	$	(0.02	)	$	0.12

Net income (loss) per common share, diluted
As reported	$	(0.00	)	$	0.14

Pro forma	$	(0.02	)	$	0.11


	December 31, 2004			September 30, 2004
Technology	$	9,398		$	9,398
Customer base		3,388			3,388
Non-compete		260			260
Trade name		469			469

		13,515			13,515
Accumulated amortization		(6,404	)		(5,823	)

Total other intangible assets, net	$	7,111		$	7,692


Fiscal Year
Remainder of 2005	$	2,351
2006		2,753
2007		1,115

	$	6,219


	December 31,				September 30,
	2004		2003		2004
Customer deposits	$	10,516	$	10,875	$	10,957
Deferred software license revenue		19,509		15,061		17,234
Other deferred revenue		25,954		17,065		23,863
Unearned revenue		31,491		26,027		31,326

Total backlog	$	87,470	$	69,028	$	83,380


Fiscal Year	Operating Leases		Telecommunications Contracts and Other		Total Future Obligations
Less than one year (before 9/30/2005)	$	2,351	$	670	$	3,021
One to three years (10/1/2005–9/30/2008)		3,868		1,431		5,299

Total	$	6,219	$	2,101	$	8,320


2.1		Agreement and Plan of Merger Among Elekta AB (Publ), Erbium Acquisition Corporation and IMPAC Medical Systems, Inc., dated as of January 17, 2005 (incorporated by reference from Exhibit 2.1 to IMPAC’s Form 8-K filed January 19, 2005).

10.1		Severance Agreement between IMPAC Medical Systems, Inc. and Kendra Borrego, dated as of January 17, 2005 (incorporated by reference from Exhibit 10.1 to IMPAC’s Form 8-K filed January 19, 2005).

10.2		Elekta Sales Consultancy Agreement, dated October 5, 2004 between IMPAC and Elekta Limited.*

31.1		Certification of Principal Executive Officer Pursuant to Rule 13a-14(b).

31.2		Certification of Principal Financial Officer Pursuant to Rule 13a-14(b).

32.1		Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350.



32.2		Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350.

99.1		Form of Stockholder Agreement entered into by and among Elekta AB (publ), Erbium Acquisition Corporation and IMPAC Medical Systems, Inc. (incorporated by reference from Exhibit 99.2 to IMPAC’s Form 8-K filed January 19, 2005).