UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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

Commission File Number: 001-33452

TomoTherapy Incorporated

(Exact name of registrant as specified in its charter)

Wisconsin (State or other jurisdiction of incorporation or organization)		39-1914727 (I.R.S. Employer Identification No.)
1240 Deming Way, Madison, Wisconsin (Address of principal executive offices)		53717 (Zip Code)

(608) 824-2800
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

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

Number of shares of common stock outstanding as of October 29, 2010: 55,911,666 shares.

 

 

TomoTherapy Incorporated and Subsidiaries
Index

		Page
Part I. FINANCIAL INFORMATION			3
Item 1. Financial Statements (unaudited)			3
Condensed Consolidated Balance Sheets			3
Condensed Consolidated Statements of Operations			4
Condensed Consolidated Statements of Cash Flows			5
Condensed Consolidated Statements of Equity			6
Notes to Condensed Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 3. Quantitative and Qualitative Disclosures about Market Risk			23
Item 4. Controls and Procedures			23
Part II. OTHER INFORMATION			24
Item 1. Legal Proceedings			24
Item 1A. Risk Factors			24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			25
Item 6. Exhibits			25
SIGNATURES			26
EXHIBIT INDEX			27
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

TOMOTHERAPY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(unaudited)

		September 30,				December 31,
		2010				2009
ASSETS
Cash and cash equivalents (CPAC balances of $2,499 and $1,590)		$	110,424			$	76,108
Short-term investments			29,612				78,225
Receivables, net of allowances of $1,216 and $737			34,047				33,559
Inventories, net			53,014				47,669
Prepaid expenses and other current assets (CPAC balances of $312 and $494)			3,352				3,633
Total current assets			230,449				239,194
Property and equipment, net (CPAC balances of $2,008 and $555)			21,305				18,628
Other non-current assets, net (CPAC balances of $109 and $30)			11,168				12,429
TOTAL ASSETS		$	262,922			$	270,251
LIABILITIES AND EQUITY
Accounts payable (CPAC balances of $450 and $24)		$	14,095			$	6,269
Accrued expenses (CPAC balances of $326 and $20)			24,056				19,588
Accrued warranty			4,115				4,173
Deferred revenue			30,877				34,145
Customer deposits			14,801				13,266
Total current liabilities			87,944				77,441
Other non-current liabilities (CPAC balances of $18 and $18)			3,213				5,475
TOTAL LIABILITIES			91,157				82,916
Preferred stock: authorized 10,000,000 shares of $1 par value; no shares issued and outstanding			—				—
Common stock: authorized 200,000,000 shares of $0.01 par value; 55,961,847 and 53,980,728 shares issued; 55,829,706 and 53,938,955 shares outstanding			528				515
Additional paid-in capital			674,182				667,177
Treasury stock, at cost: 132,141 and 41,773 shares			(447	)			(137	)
Accumulated other comprehensive loss			(904	)			(268	)
Accumulated deficit			(507,400	)			(483,863	)
Total shareholders’ equity			165,959				183,424
Noncontrolling interests			5,806				3,911
TOTAL EQUITY			171,765				187,335
TOTAL LIABILITIES AND EQUITY		$	262,922			$	270,251

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

TOMOTHERAPY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2010				2009				2010				2009
Revenue:
Product		$	29,759			$	24,252			$	93,230			$	75,937
Service and other			13,823				10,126				40,062				30,144
Total revenue			43,582				34,378				133,292				106,081
Cost of revenue:
Product			16,233				13,782				46,372				39,779
Service and other			20,339				17,038				54,848				51,690
Total cost of revenue			36,572				30,820				101,220				91,469
Gross profit			7,010				3,558				32,072				14,612
Operating expenses:
Research and development			8,228				7,218				24,728				20,086
Selling, general and administrative			14,390				12,470				37,334				34,347
Total operating expenses			22,618				19,688				62,062				54,433
Loss from operations			(15,608	)			(16,130	)			(29,990	)			(39,821	)
Other income (expense):
Interest income			342				617				1,289				2,009
Interest expense			(4	)			(18	)			(27	)			(47	)
Other income (expense), net			1,539				105				513				(258	)
Total other income (expense)			1,877				704				1,775				1,704
Loss before income taxes			(13,731	)			(15,426	)			(28,215	)			(38,117	)
Income tax expense (benefit)			47				256				13				(162	)
Net loss			(13,778	)			(15,682	)			(28,228	)			(37,955	)
Noncontrolling interests			1,842				1,802				4,691				3,953
Net loss attributable to shareholders		$	(11,936	)		$	(13,880	)		$	(23,537	)		$	(34,002	)
Weighted-average common shares outstanding - basic and diluted			51,934				50,748				51,739				50,645
Net loss per common share — basic and diluted		$	(0.23	)		$	(0.27	)		$	(0.45	)		$	(0.67	)

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

TOMOTHERAPY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)

		Nine Months Ended September 30,
		2010				2009
Cash flows from operating activities:
Net loss		$	(28,228	)		$	(37,955	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			7,552				8,147
Share-based compensation			5,940				4,406
Deferred income tax benefit			(45	)			(360	)
Other noncash items			(8	)			167
Changes in operating assets and liabilities:
Receivables, net			2				19,849
Inventories, net			(6,313	)			2,234
Prepaid expenses and other current assets			(2,111	)			(1,252	)
Accounts payable			7,818				51
Accrued expenses			3,200				(576	)
Accrued warranty			(58	)			(3,634	)
Deferred revenue			(4,758	)			1,308
Customer deposits			1,535				(1,700	)
Net cash used in operating activities			(15,474	)			(9,315	)
Cash flows from investing activities:
Purchases of property and equipment			(3,619	)			(1,685	)
Purchases of short-term investments			—				(7,499	)
Proceeds from sales and maturities of short-term investments			47,750				17,376
Other investing activities			(850	)			(3,130	)
Net cash provided by investing activities			43,281				5,062
Cash flows from financing activities:
Payments on notes payable			(102	)			(101	)
Repurchases of common stock			(310	)			(123	)
Proceeds from exercises of stock options and warrants			1,078				130
Proceeds from issuance of CPAC common stock			6,586				6,863
Net cash provided by financing activities			7,252				6,769
Effect of exchange rate changes on cash and cash equivalents			(743	)			44
Increase in cash and cash equivalents			34,316				2,560
Cash and cash equivalents at beginning of period			76,108				65,967
Cash and cash equivalents at end of period		$	110,424			$	68,527

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

TOMOTHERAPY INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(In thousands)
(unaudited)

		Shareholders’ Equity
														Accumulated
						Additional								Other
		Common				Paid-in				Treasury				Comprehensive				Accumulated				Noncontrolling
		Stock				Capital				Stock				Income (Loss)				Deficit				Interests				Total Equity
Balance at December 31, 2008		$	506			$	659,379			$	—			$	202			$	(446,493	)		$	2,155			$	215,749
Net loss			—				—				—				—				(34,002	)			(3,953	)			(37,955	)
Other comprehensive loss			—				—				—				108				—				—				108
Comprehensive loss																											(37,847	)
Issuance of common stock			—				—				—				—				—				6,863				6,863
Exercise of common stock warrants			4				126				—				—				—				—				130
Repurchases of common stock			—				—				(123	)			—				—				—				(123	)
Share-based compensation expense			—				4,406				—				—				—				—				4,406
Balance at September 30, 2009		$	510			$	663,911			$	(123	)		$	310			$	(480,495	)		$	5,065			$	189,178
Balance at December 31, 2009		$	515			$	667,177			$	(137	)		$	(268	)		$	(483,863	)		$	3,911			$	187,335
Net loss			—				—				—				—				(23,537	)			(4,691	)			(28,228	)
Other comprehensive loss			—				—				—				(636	)			—				—				(636	)
Comprehensive loss																											(28,864	)
Issuance of common stock			—				—				—				—				—				6,586				6,586
Issuance of restricted stock			10				(10	)			—				—				—				—				—
Exercise of stock options			4				1,074				—				—				—				—				1,078
Repurchases of common stock			(1	)			1				(310	)			—				—				—				(310	)
Share-based compensation expense			—				5,940				—				—				—				—				5,940
Balance at September 30, 2010		$	528			$	674,182			$	(447	)		$	(904	)		$	(507,400	)		$	5,806			$	171,765

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

TOMOTHERAPY INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE A — BACKGROUND AND BASIS OF PRESENTATION

Organization

The organization is comprised of TomoTherapy Incorporated, a Wisconsin corporation (Tomo), its wholly-owned subsidiaries and its minority-owned affiliate (collectively, together with Tomo, the Company). Tomo and its wholly-owned subsidiaries (TomoTherapy) develop, manufacture, market and sell advanced radiation therapy solutions to treat a wide range of cancer types. The treatment systems in the Company’s product offering (collectively, the System or Systems) include: (1) the flagship Hi Art treatment system, which delivers CT-guided, helical intensity-modulated radiation therapy (IMRT) treatment fractions; (2) the TomoHD treatment system, which includes both the TomoHelical and TomoDirect treatment modalities; and (3) the TomoMobile treatment system, which is a relocatable radiation therapy solution. TomoTherapy markets and sells its Systems to hospitals and cancer treatment centers in the Americas, Europe, the Middle East and Asia-Pacific. Compact Particle Acceleration Corporation (CPAC), Tomo’s controlled, minority-owned affiliate, is an enterprise focused on the development of a proton therapy system.

Principles of Consolidation

The Company’s condensed consolidated financial statements include the accounts of CPAC. Although Tomo’s ownership in CPAC is less than 50%, it has consolidated CPAC, as Tomo is the primary beneficiary of CPAC, due to its overall control of CPAC’s activities and Tomo’s ownership interest in CPAC. CPAC’s outside stockholders’ interests are shown in the Company’s condensed consolidated financial statements as “Noncontrolling interests.” Intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and pursuant to the accounting and disclosure rules and regulations of the Securities and Exchange Commission (SEC) for interim financial information. Certain information and disclosures normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the SEC. In the opinion of management, all adjustments, consisting of a normal recurring nature, considered necessary for a fair presentation have been included in the condensed consolidated financial statements. Interim results are not necessarily indicative of results for the full year ending December 31, 2010.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at the date of the condensed consolidated financial statements and the reported amount of revenues, expenses and cash flows during the periods presented. Actual results could differ from those estimates and assumptions.

Fair Value of Financial Instruments

The Company’s financial instruments consist primarily of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and long-term debt. The carrying value of cash and cash equivalents, accounts receivable, accounts payable and long-term debt approximate their respective fair values as of September 30, 2010 and December 31, 2009. The fair value of short-term investments is based on quoted prices for similar items in active markets.

NOTE B — RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the Financial Accounting Standards Board (FASB) issued revised guidance for the accounting of variable interest entities. This revised guidance replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and has the obligation to absorb losses or the right to receive benefits from the entity that could be potentially significant to the variable interest entity. The accounting guidance also requires an ongoing reassessment of whether an enterprise is the primary beneficiary and requires additional disclosures about an enterprise’s involvement in variable interest entities. The adoption of this accounting guidance, which became effective for the Company beginning in the first quarter of fiscal 2010, did not have a material impact on the Company’s condensed consolidated financial statements.

In September 2009, the FASB amended the accounting guidance on revenue recognition (“new revenue guidance”). Under the new revenue guidance, consideration in a multiple element arrangement may now be allocated in a manner that more closely reflects the structure of the transaction. Also, under the new revenue guidance, tangible products that contain software components essential to the functionality of the tangible product will no longer be subject to software revenue recognition guidance and will now be subject to other revenue guidance.

The Company elected to early adopt this new revenue guidance at the beginning of its first quarter of fiscal 2010 on a prospective basis for applicable arrangements originating or materially modified on or after January 1, 2010. For the first nine months of 2010, adoption of the new revenue guidance did not have a material impact on the Company’s condensed consolidated financial statements, and the Company does not expect the new revenue guidance will have a material impact on its consolidated financial statements in future periods.

NOTE C — SUPPLEMENTAL FINANCIAL INFORMATION

Short-term Investments

Investments consisted of the following (in thousands):

		September 30, 2010
		Cost basis				Unrealized gains				Unrealized losses				Fair value
U.S. government and U.S. governmental agency securities		$	20,101			$	543			$	—			$	20,644
Corporate bonds			8,794				174				—				8,968
		$	28,895			$	717			$	—			$	29,612

		December 31, 2009
		Cost basis				Unrealized gains				Unrealized losses				Fair value
U.S. government and U.S. governmental agency securities		$	60,531			$	1,043			$	—			$	61,574
Corporate bonds			16,334				317				—				16,651
		$	76,865			$	1,360			$	—			$	78,225

The remaining maturities of debt securities were as follows (in thousands):

		September 30, 2010								December 31, 2009
		Cost basis				Fair value				Cost basis				Fair value
Due in one year or less		$	17,718			$	18,041			$	48,345			$	48,809
Due after one year through five years			11,177				11,571				28,520				29,416
		$	28,895			$	29,612			$	76,865			$	78,225

The Company determines the fair value of its investments using a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:

	•		Level 1 — Quoted prices in active markets for identical assets or liabilities.
	•		Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
	•		Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

As of September 30, 2010, the Company’s financial assets, which consist of its investments, were measured at fair value employing Level 2 inputs.

Inventories, net

Net inventories consisted of the following (in thousands):

		September 30,				December 31,
		2010				2009
Raw materials		$	41,023			$	40,091
Work-in-process			5,516				1,847
Finished goods			6,475				5,731
		$	53,014			$	47,669

Accrued Warranty

The Company’s sales terms include a warranty that typically covers the first year of System operation and is based on terms that are generally accepted in the marketplace. The Company records a current liability for the expected cost of warranty-related claims at the time of sale.

The following table presents changes in the Company’s product warranty accrual (in thousands):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2010				2009				2010				2009
Balance, beginning of period		$	3,776			$	4,907			$	4,173			$	7,431
Charged to cost of revenue			1,430				1,772				4,640				5,313
Charged to selling, general and administrative			—				—				—				282
Adjustments related to change in estimate			—				(960	)			(940	)			(2,933	)
Actual product warranty expenditures			(1,091	)			(1,922	)			(3,758	)			(6,296	)
Balance, end of period		$	4,115			$	3,797			$	4,115			$	3,797

Deferred Revenue

Deferred revenue is recorded on a gross basis until the revenue is recognized. Deferred revenue includes amounts primarily related to services and, to a lesser extent, amounts related to product sales, including in-transit Systems that have shipped to the Company’s direct customers or non-certified distributors but are not yet installed and accepted by the end customer. The Company ultimately expects to recognize these amounts as revenue upon performance of the services or when the Company’s product has been delivered and accepted by the customer.

The costs of revenue associated with services primarily relate to spare parts inventory along with the direct labor charges corresponding to post-warranty maintenance, which are recognized as incurred over the term of the service contract. The costs of revenue associated with product sales are comprised primarily of finished goods inventory, along with the corresponding installation costs.

Deferred revenue with expected recognition dates that exceed one year is classified in the condensed consolidated financial statements as “Other non-current liabilities.” As of September 30, 2010 and December 31, 2009, the Company’s non-current deferred revenue was $1.4 million and $2.7 million, respectively.

Other Comprehensive Income (Loss)

Other comprehensive income (loss) refers to revenue, expenses, gains and losses that, under U.S. GAAP, are included in other comprehensive income (loss), but are excluded from net income (loss), as these amounts are recorded as a direct adjustment to shareholders’ equity, net of tax, when applicable. The Company generated other comprehensive income of $0.2 million for the three month periods ended September 30, 2010 and 2009. The Company had other comprehensive loss of $0.6 million and other comprehensive income of $0.1 million for the nine months ended September 30, 2010 and 2009, respectively.

NOTE D — NET LOSS PER COMMON SHARE

The Company calculates its loss per common share using the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. Under that method, income from continuing operations (or net income) is reduced by the amount of dividends declared in the current period for each class of stock and by the contractual amount of dividends (or interest on participating income bonds) that must be paid for the current period. The remaining earnings are allocated to common stock and participating securities to the extent that each security may share in earnings as if all of the earnings for the period had been distributed. The total earnings allocated to each security are determined by adding together the amount allocated for dividends and the amount allocated for a participation feature. The total earnings allocated to each security are divided by the number of outstanding shares of the security to which the earnings are allocated to determine the earnings per share for the security.

For the three and nine months ended September 30, 2010 and 2009, diluted net loss per share was the same as basic net loss per share since the effects of potentially dilutive securities are anti-dilutive.

Historical outstanding anti-dilutive securities not included in net loss per share calculation are as follows (in thousands):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2010				2009				2010				2009
Stock options			4,528				5,667				4,528				5,667
Restricted stock			3,058				2,606				3,058				1,517
			7,586				8,273				7,586				7,184

NOTE E — SEGMENT INFORMATION

The Company has determined that it operates in only one segment, as it only reports profit and loss information on an aggregate basis to its chief operating decision maker.

The following table summarizes revenue by geographic region (in thousands):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2010				2009				2010				2009
Americas (1)		$	16,627			$	24,567			$	56,283			$	68,171
Europe and Middle East			15,607				1,670				51,171				20,258
Asia-Pacific			11,348				8,141				25,838				17,652
		$	43,582			$	34,378			$	133,292			$	106,081

NOTE F — INCOME TAXES

The estimated annual effective tax rate is adjusted quarterly, and items discrete to a specific quarter are reflected in tax expense for that interim period. The estimated annual effective income tax rate includes the effect of a valuation allowance expected to be necessary at the end of the year for deferred tax assets related to originating deductible temporary differences and carryforwards during the year. A valuation allowance is established when necessary to reduce deferred tax assets to an amount more-likely-than-not to be realized.

For the three months ended September 30, 2010, the Company recorded income tax expense resulting in an effective income tax rate of (0.3)%, and for the nine months ended September 30, 2010, the Company recorded an income tax expense resulting in an effective tax rate of (0.05)%. The effective tax rate for the period differed significantly from the statutory tax rate primarily due to maintaining a valuation allowance for deferred tax assets in domestic and certain foreign taxing jurisdictions that do not attain the more-likely-than-not realization threshold. For the three months ended September 30, 2009, the Company recorded an income tax expense resulting in an effective income tax rate of (1.7)%, and for the nine months ended September 30, 2009, recorded an income tax benefit of 0.4%. There were no material changes in unrecognized tax benefits during the three and nine months ended September 30, 2010.

NOTE G — COMMITMENTS AND CONTINGENCIES

On occasion, the Company is subject to proceedings, lawsuits and other claims related to patents, products and other matters. The Company assesses the likelihood of any adverse judgments or outcomes with respect to these matters and determines loss contingency assessments on a gross basis after assessing the probability of incurrence of a loss and whether a loss is reasonably estimable. In addition, the Company considers other relevant factors that could impact its ability to reasonably estimate a loss. A determination of the amount of reserves required, if any, for these contingencies is made after analyzing each matter. The Company’s reserves may change in the future due to new developments or changes in the strategy of handling these matters.

Securities Litigation

On May 30, 2008 and June 10, 2008, two separate complaints were filed by certain shareholders of the Company in the U.S. District Court for the Western District of Wisconsin (the Court) against the Company and certain of its officers and all of its independent directors during the period in question. The complaints were consolidated on October 23, 2008. In the consolidated action (the 2008 Securities Litigation), the plaintiffs allege that the defendants violated the Securities Act of 1933 (the Securities Act) with respect to statements made in connection with the initial and secondary public offerings of the Company’s common stock and the Securities Exchange Act of 1934 (Exchange Act) by misrepresenting the Company’s projected financial outlook during the period May 9, 2007 through April 17, 2008. The named plaintiffs, Michael Schultz, John Scala, et al., seek to represent persons who purchased the Company’s securities between those dates and who were damaged as a result of the decline in the price of the Company’s stock between those dates, allegedly attributable to the financial misrepresentations, and seek compensatory damages in an unspecified amount.

The Company moved to dismiss the consolidated complaint on December 8, 2008. On July 9, 2009, the Court ruled on the motion to dismiss the consolidated complaint by dismissing without prejudice all claims under the Exchange Act and all but one claim under the Securities Act for failure to state a claim upon which relief could be granted. On August 3, 2009, the plaintiffs amended the consolidated complaint by filing their Second Amended Consolidated Complaint (the Amended Complaint). The Company moved to dismiss the Amended Complaint on September 3, 2009, and on December 15, 2009, the Court granted this second motion to dismiss in part and denied it in part. The plaintiffs have moved for class certification.

However, on July 28, 2010, the Company entered into an agreement to settle the 2008 Securities Litigation. Under the proposed settlement, the claims against the Company and its officers and directors would be dismissed with prejudice and released in exchange for a cash payment of $5.0 million to be funded by the Company’s insurance carrier. The proposed settlement remains subject to the satisfaction of various conditions, including negotiation and execution of a final stipulation of settlement and approval by the Court following notice to members of the purported class. On September 20, 2010, the Court preliminarily approved the terms for distribution of the settlement fund to purported class members, less fees awarded by the Court to class counsel, and other terms of the settlement. Final approval of the settlement will follow notification to class members.

The Company continues to believe that it has substantial legal and factual defenses to the allegations contained in the Amended Complaint, and it intends to pursue these defenses vigorously if the proposed settlement is not finalized and approved by the Court. If the settlement is not finalized and the 2008 Securities Litigation instead continues, although the Company carries insurance for these types of claims and related defense costs, a judgment significantly in excess of the Company’s insurance coverage could materially and adversely affect the Company’s financial condition, results of operations and cash flows. As of September 30, 2010, the Company estimated that its potential loss from these claims and related defense costs will not exceed its insurance deductible of $0.5 million, whether or not the proposed settlement is finalized and approved by the Court.

Stockholder Derivative Actions

On May 28, 2010 and July 9, 2010, two separate derivative lawsuits were filed in the Circuit Court of Dane County in Madison, Wisconsin by certain shareholders of the Company against (a) certain officers and all of the persons who have served as directors of the Company since May 9, 2007 (collectively, the Individual Defendants) and (b) the Company, as nominal defendant. In their respective complaints (together, the Complaints), each of the named plaintiffs, The Dixon Family Living Trust and David Huh, allege that all of the Individual Defendants breached their fiduciary duties and engaged in abuse of control, gross mismanagement and waste of corporate assets, and that certain Individual Defendants were unjustly enriched. The Complaints were consolidated on October 11, 2010. The allegations are substantially similar to those claims made in the 2008 Securities Litigation. The Complaints seek damages, equitable relief, restitution and disgorgement of profits, costs and disbursements of the action, and other relief the court deems proper.

The Company and the Individual Defendants believe that there are substantial legal and factual defenses to the allegations contained in the Complaints. Moreover, the Company and the Individual Defendants carry insurance for these types of claims and related defense costs. As of September 30, 2010, the Company estimated that it would not incur any material costs in connection with these claims or the defense thereof, given that the Company has already paid the applicable $0.5 million insurance deductible in connection with the 2008 Securities Litigation.

In March 2010, the Company received two shareholder demand letters from attorneys representing other shareholders (together, the Demand Letters) containing allegations substantially similar to those made in the Complaints. To the Company’s knowledge, as of the date of this Quarterly Report on Form 10-Q, no lawsuits have been filed against the Company or any Individual Defendants in connection with the Demand Letters.

Reserve for Contingency

On July 17, 2009, Hi-Art Co., Ltd. (Hi-Art), the Company’s former distributor in Japan, filed a complaint against the Company in the Tokyo District Court seeking compensation it claims is owed by the Company. Although the Company believes it has substantial legal and factual defenses to Hi-Art’s allegations and intends to pursue these defenses vigorously, there can be no assurance that the Company will prevail. Accordingly, the Company maintains a reserve with respect to this matter.

Operating Leases

The Company leases six facilities under separate operating leases with various expiration dates through 2018. The Company also leases automobiles under separate operating leases with various expiration dates through 2013. Rent expense was $1.1 million and $1.2 million during the three months ended September 30, 2010 and 2009, respectively, and $3.4 million and $3.6 million during the nine months ended September 30, 2010 and 2009, respectively.

Initial terms for facility leases are up to 13 years, with renewal options at various intervals, and include rent escalation clauses. The total amount of the minimum rent payments is expensed on a straight-line basis over the initial term of the lease unless external economic factors exist such that renewals are reasonably assured, in which case the Company includes the renewal period in its amortization period. Most of the leases provide that the Company pay taxes, maintenance, insurance and certain other expenses applicable to the leased premises. The Company expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases.

NOTE H — STOCK INCENTIVE PLANS

The Company sponsors two stock incentive plans (the Plans), which allow for the grant of incentive stock options, nonqualified stock options and restricted stock. Each option grant entitles the holder to purchase a specified number of shares of Tomo common stock at a specified price that may not be less than the fair market value on the grant date. Although the option grants under the Plans may have a maximum life of up to ten years, the majority of the grants made to date have lives of six years and vest at various intervals. Each restricted stock grant entitles the holder to receive a specified number of Tomo shares of common stock and vests at various intervals. Vesting schedules are determined at the grant date by the Compensation Committee of Tomo’s Board of Directors.

The Company’s Board of Directors and shareholders approved the 2007 Equity Incentive Plan and approved an amendment thereto in March 2009 (as amended, the 2007 Plan). Under the 2007 Plan, the Company’s Board of Directors is authorized to grant stock-based awards to employees, directors, and consultants for up to 7,335,822 shares in aggregate. As of September 30, 2010, the Plans remained in effect; however, new equity-based awards may only be granted under the 2007 Plan.

The following table summarizes the activity under the Plans (in thousands, except for weighted-average exercise price and weighted-average fair value at grant date):

						Incentive Stock Options								Restricted Stock
																		Weighted-
		Shares				Number of				Weighted-								Average
		Available				Options				Average				Number of				Fair Value
		for Grant				Outstanding				Exercise Price				Shares				at Grant Date
Balance at December 31, 2009			3,667				5,347			$	5.02				2,488			$	5.01
Granted			(1,744	)			—				—				1,744				3.17
Exercised or vested			—				(386	)			2.80				(1,025	)			5.18
Cancelled			185				(433	)			6.46				(149	)			4.88
Balance at September 30, 2010			2,108				4,528			$	5.07				3,058			$	3.91
Exercisable at September 30, 2010							3,929			$	4.73

At September 30, 2010, the Company’s weighted-average remaining contractual term was 2.8 years for all outstanding stock options, 2.8 years for outstanding vested stock options and 2.3 years for restricted stock. In addition, the Company’s aggregate intrinsic value was $1.6 million for all outstanding stock options and $1.5 million for vested stock options that were outstanding at September 30, 2010.

NOTE I — INVESTMENT IN COMPACT PARTICLE ACCELERATION CORPORATION

During April 2008, Tomo established a new affiliate, CPAC, to develop a compact proton therapy system for the treatment of cancer. CPAC’s investors include Tomo, private investors and potential customers.

Although Tomo’s ownership in CPAC is less than 50%, it has consolidated CPAC, as Tomo is the primary beneficiary of CPAC, due to its overall control of CPAC’s activities and Tomo’s ownership interest in CPAC. Therefore, CPAC’s outside shareholders’ interests are shown in the Company’s condensed consolidated financial statements as “Noncontrolling interests”. Tomo contributed intellectual property with a fair market value of approximately $1.9 million as its investment in CPAC. CPAC raised additional capital from third-party investors of $6.6 million during the nine months ended September 30, 2010. As of September 30, 2010 and December 31, 2009, Tomo’s ownership interest in CPAC was 5.3% and 7.3%, respectively.

Other than a previous contractual agreement to provide certain support and management services, Tomo has not provided financial or other support to CPAC, and although Tomo may provide additional financial support to CPAC in the future, Tomo currently has no contractual obligation to provide future financial support beyond the aforementioned services. Settlement of CPAC’s obligations are restricted to the assets of CPAC. The creditors and beneficial interest holders of CPAC have no recourse to TomoTherapy.

NOTE J — RESTRUCTURING

In October 2009, Tomo’s management approved a restructuring program to downsize certain customer service and administrative functions and to terminate the employment of 61 employees during the period from October 14 through December 31, 2009. As a result of the restructuring program, the Company recognized a total restructuring charge of $1.9 million in the fourth quarter of 2009. A summary of activity for this liability is as follows (in thousands):

Balance at December 31, 2009		$	998
Additions			—
Payments			(995	)
Balance at September 30, 2010		$	3

The remaining liability at September 30, 2010 is expected to be paid in the fourth quarter of 2010.

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

The following discussion should be read together with our unaudited condensed consolidated financial statements and the notes to those financial statements, which are included in this report. This report may contain or incorporate by reference forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These statements reflect management’s expectations, estimates and assumptions, based on information available at the time of the statement or, with respect to any document incorporated by reference, available at the time that such document was prepared. Forward-looking statements include, but are not limited to, statements regarding future events, plans, goals, objectives, prospects and expectations. Forward-looking statements are often, but not always, made through the use of words such as “believe,” “anticipate,” “should,” “intend,” “plan,” “will,” “likely,” “expect,” “estimate,” “project” and similar expressions. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and other factors, including, but not limited to, those discussed below under “Factors Affecting Our Financial Performance” and those in the section entitled “Risk Factors” under Part II, Item 1A. of this Quarterly Report on Form 10-Q, which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by those statements. We undertake no obligation to, and expressly disclaim any such obligation to, update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events or changes to future results over time or otherwise, except as required by law.

Overview

We develop, manufacture, market and sell advanced radiation therapy solutions to treat a wide range of cancer types. We market and sell our products to hospitals and cancer treatment centers in the Americas, Europe, the Middle East and Asia-Pacific and offer customer support services in each region either directly or through distributors.

The treatment systems in our TomoTherapy product offering (collectively, the System or Systems) operate on a ring gantry and combine integrated CT imaging with conformal radiation therapy to deliver sophisticated radiation treatments with speed and precision while reducing radiation exposure to surrounding healthy tissue. Our Systems include: (1) the Hi Art treatment system; (2) the TomoHD treatment system; and (3) the TomoMobile relocatable radiation therapy solution. The Hi Art treatment system is our flagship product and has been used since 2003 to deliver CT-guided, helical intensity-modulated radiation therapy (IMRT) treatment fractions. The TomoHD treatment system was announced in October 2009, is targeted for shipment in the fourth quarter of 2010 and includes both our TomoHelical and TomoDirect treatment modalities to enable cancer centers to treat a broader patient population with a single device. The TomoMobile relocatable radiation therapy solution was first shipped in late 2009, consists of a standard TomoTherapy treatment system housed in a movable coach, and is designed to improve the access and availability of state-of-the-art cancer care.

For the nine months ended September 30, 2010 and 2009, our revenue was $133.3 million and $106.1 million, respectively, an increase of 26%, and our net loss attributable to shareholders was $23.5 million and $34.0 million, respectively, a decrease of 31%. Our results of operations for the nine months ended September 30, 2010 improved over the comparable 2009 period despite the continued impact of the global economic downturn, limited credit availability and enhanced competitive pressure. Although we experienced a net loss in the first nine months of 2010, we had a working capital balance of $142.5 million, including $140.0 million of cash, cash equivalents and short-term investments, as of September 30, 2010. Thus, we believe we will be able to fund ongoing operations and to invest in future product offerings for at least the next 12 months.

Despite continued economic uncertainty in 2010, we are encouraged by the improvements in our financial results, and we remain confident in the future commercial demand for our technology and product offerings due to planned new products, product enhancements and anticipated growth in global demand for CT image-guided radiation therapy equipment.

Factors Affecting Our Financial Performance

Our financial performance is significantly affected by the following factors:

Incoming orders

Since we sell high-priced capital equipment with a transaction cycle that can take many months between customer order and delivery, an important measure of our future financial performance is the dollar value of incoming orders for equipment. During the first nine months of 2010, we experienced an increase in incoming orders as compared to the first nine months of 2009, despite the continued impact of the global economic downturn, limited credit availability and increased competitive pressure. We believe this increase in orders is the result of improvements generated by the transition in sales leadership we implemented during 2009, recent product introductions and the successful execution of our global sales and marketing efforts.

Since the System is a major capital expenditure, our customers may require funding through a credit facility or lease arrangement. In the current economic environment, some customers may have difficulty obtaining the necessary credit or are subject to increased constraints on their use of available cash. In addition, the current economic environment may cause potential new customers to delay placing capital equipment orders or to purchase equipment that is less costly.

We are still experiencing heightened competition in the marketplace; see Item 1A. Risk Factors in Part II of the Quarterly Report on Form 10-Q for the period ending June 30, 2010 for further information. To counter this competitive pressure, we continue our efforts to improve the quality and effectiveness of our sales force, increase our focus on group purchasing organizations and national accounts, increase our emphasis on regional user meetings and expand our product features. We have also extended our product portfolio from one to three market offerings. Furthermore, we believe continued innovation and expansion of our clinical capabilities will extend our technology leadership position, increase our prospects for greater market share and generate revenue growth.

Backlog

As of September 30, 2010, we had a backlog of $146.4 million, the majority of which we believe should convert to revenue within the next 12 months. We define backlog as the total contractual value of all firm orders received for the System and related options that we believe are likely to ship within 24 months and the minimum payments that are contractually obligated under system rental agreements. To be included in backlog, orders must be evidenced by a signed quotation or purchase order from the customer or distributor.

On a regular basis, we review our open orders to determine if they meet our backlog definition by evaluating various factors including site identification, requested delivery date and customer or distributor history. If they no longer meet our backlog definition, we remove the orders from our backlog.

Revenue

Product revenue. The majority of our product revenue is generated from sales of the System. We negotiate the actual purchase price with each customer or distributor and, historically, the purchase price has varied across geographic regions.

We are starting to see some improvement in the market, most notably in the Americas which has historically been our largest market, including an increase in new orders for the first nine months of 2010 as compared to the first nine months of 2009. In addition, we expect our 2010 revenue to improve in comparison to 2009 revenue. We continue to be confident in the future commercial demand for our technology and product offerings due to our new products, new features and anticipated growth in demand for CT image-guided radiation therapy equipment.

Our revenue projections can be impacted by a number of factors, including the following:

	•		On average, the System is shipped to our customer within 12 months after we receive the order. However, individual orders may take longer than 12 months to ship. Timing of deliveries can be affected by factors outside of our control, such as construction delays at customer project sites and customer credit issues. For direct and non-certified distributor sales, we recognize revenue upon end customer acceptance of the System, which usually occurs three to four weeks after its delivery. For certified distributor sales, we recognize revenue upon title transfer of the System to the certified distributor. Each System installation represents a significant percentage of our revenue for the period in which it occurs.
	•		Our geographic mix of customers may impact our average selling prices. We intend to continue to expand our international selling efforts, although we cannot be certain that favorable pricing trends will continue. As of September 30, 2010, we did not have a hedging program in place to offset foreign exchange risk and, therefore, cannot be certain of how foreign currency exchange rates will impact our financial results in the future.
	•		Our ability to demonstrate the clinical benefits of the System compared to competing systems is a factor in our ability to increase market demand for the System. To compete effectively, we may need to offer additional features that could require substantial additional resources to develop.
	•		Our focus on sales to group purchasing organizations (GPOs) and multi-center customers may result in us lowering selling prices, as these customers tend to negotiate quantity discounts. Orders from these customers may remain in backlog longer than those from customers who place single unit orders, as units sold to multi-center customers tend to install sequentially over a longer period of time.

•

The System is a major capital equipment item that represents a significant purchase for most of our customers. While we believe macroeconomic conditions are improving, our customers remain cautious and, as a result, may choose to delay some of their capital spending or may not have or be able to obtain the funds necessary to purchase equipment such as the System. These factors may have a material adverse effect on our incoming orders and subsequent revenue recognition.

Also included in our product revenue are sales of optional equipment and software enhancements. Because we plan to further develop the System by adding upgraded features, we expect continued revenue growth from sales of optional equipment and software enhancements to new and existing customers.

Service revenue. Our service revenue is generated primarily from post-warranty service contracts and the sale of service spare parts. Our service contracts may be purchased with one- or multiple-year terms and for a variety of service levels, giving our customers the option to contract for the level of support they desire. As of September 30, 2010, our most popular service plan continued to be our Total TLC Service Package (Total TLC). Under Total TLC, we provide customers with full spare parts coverage, including installation service by our field service engineers, full scheduled maintenance and unplanned repair service. We recognize service contract revenue ratably over the term of the contract. We generally recognize revenue from spare parts, which are primarily sold to our distributors, upon delivery. As the number of installed Systems continues to grow, we expect growth in our revenue from post-warranty service contracts.

Our ability to execute our strategies to increase incoming orders, expand backlog with high quality orders, raise sales of optional equipment and software enhancements and grow our service revenue will have a direct impact on our ability to increase overall revenue in the future. If we are unable to execute these strategies successfully, we may generate revenue at levels that are lower than those we have generated in the past.

Cost of revenue

Cost of revenue includes all of our manufacturing and service costs. It consists of material, labor and overhead costs incurred in manufacturing the System. It also includes the cost of shipping the System to the customer site, installation costs, warranty provisions and royalty payments to Wisconsin Alumni Research Foundation (WARF), one of our shareholders. Finally, cost of revenue includes the customer support expenses required to service and repair the System during both the warranty and service contract periods.

In future periods, we expect to improve our gross margins through the following initiatives:

	•		Service and support expenses. We have a number of individual service contracts that produce negative gross profit margins for which we have recorded a reserve for the related estimated future losses. We anticipate the number of contracts producing negative margins will decline as we further our efforts to reduce the overall average direct service costs per installed System. We expect to continue to improve service contract margins by leveraging our service infrastructure costs over a larger installed base, implementing remote diagnostic functionalities, outsourcing certain tasks when cost-effective and feasible, introducing component design changes aimed at reducing costs, increasing longevity and improving serviceability of our components, increasing the price for some of our older annual service contracts, and training our personnel to improve their problem-solving capabilities. Additionally, we expect to invest $3 to $4 million in our “Fast Track” program during the fourth quarter of 2010. This program targets selected older systems in the field for upgrades of certain technology. While it will have a negative impact in the fourth quarter of 2010, this program is expected to reduce the cost to service the targeted systems in future periods. We believe that achieving success in these initiatives should also lead to reduced warranty costs and improved System performance.
	•		Component supply and cost. Our cost of revenue continues to be impacted by high component costs and high replacement rates. We continue efforts to develop alternate components and implement enhancements to increase the performance of components used in the System. We are also seeking to identify lower-priced components of comparable or improved performance and quality, as well as making engineering improvements to the System in order to reduce costs. We believe that achieving these goals should result in reduced manufacturing, warranty and service support costs in the long term.

Our ability to execute on these strategies to reduce customer service and support expenses, as well as component costs and failure rates, will have a direct impact on our ability to improve profitability in the future. If we are unable to successfully execute these strategies, we may experience margins that are similar to or lower than our past margins.

Research and development expenses

Research and development expenses consist primarily of salary and benefits for research and development personnel who design and develop future products and product enhancements. Research and development also includes expenses associated with product design and development, the Compact Particle Acceleration Corporation (CPAC) proton therapy research project, customer research collaborations and fees to third parties who furnish services related to these activities.

We expect research and development expenses to increase during 2010 as compared to 2009 as we intend to increase our spending to support our ongoing product development initiatives. In addition, we expect to capitalize fewer software development costs related to ongoing product development projects in 2010 as compared to 2009.

Selling, general and administrative expenses

Selling, general and administrative expenses consist of salary and benefits for executive management, sales, marketing and other corporate functions. Also included in these expenses are travel, sales commissions, trade shows and marketing materials and expenses related to accounting, legal, tax and other consulting fees.

We expect 2010 selling, general and administrative expenses to increase as compared to 2009 as we intend to increase our selling and marketing expenses to further promote our products to our targeted markets.

Other income (expense)

Because we conduct business in numerous foreign jurisdictions, we are exposed to changes in foreign currency exchange rates. Foreign currency exchange rate fluctuations could materially adversely affect our business, financial condition and results of operations. Our primary exposures are related to foreign currency denominated sales and expenses in Europe. As of September 30, 2010, we did not have a hedging program in place to offset these risks.

Interest income

We expect interest income to decline in 2010 as compared to 2009, due to both lower levels of investable cash and reduced interest rates.

Income tax expense (benefit)

We are subject to taxation in the United States and in numerous foreign jurisdictions. Significant judgments and estimates are required when evaluating our tax positions and determining our worldwide provision for income taxes. As a result, our effective tax rate may fluctuate based on a number of factors including variations in projected taxable income and tax positions taken on tax returns filed in the numerous geographic locations in which we operate, changes in the valuation of our deferred tax assets, introduction of new accounting standards and changes in tax liabilities to address potential tax exposures related to business and income tax positions we have taken that could be challenged by taxing authorities.

When deemed necessary, valuation allowances are established to reduce deferred tax assets to amounts more-likely-than-not to be realized. This requires an assessment of both positive and negative evidence when determining whether it is more-likely-than-not that deferred tax assets will be realized. Evidence considered during the first nine months of 2010 included the existence of cumulative three-year losses, changes in backlog, projected current year losses and the negative impact of current economic conditions, which resulted in the Company maintaining its valuation allowance to offset net deferred tax assets in domestic and certain foreign taxing jurisdictions.

Noncontrolling interests

Our condensed consolidated financial statements include the accounts of CPAC. Although Tomo’s ownership in CPAC is less than 50%, Tomo has consolidated CPAC, as Tomo is the primary beneficiary of CPAC, due to its overall control of CPAC’s activities and Tomo’s ownership interest in CPAC. Therefore, CPAC’s outside stockholders’ interests are shown in our condensed consolidated financial statements as “Noncontrolling interests.” If CPAC obtains additional third-party funding, we expect our ownership percentage to continue to decline.

Results of Operations

The following table sets forth certain elements from our condensed consolidated statements of operations as a percentage of revenue for the periods indicated:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2010				2009				2010				2009
Revenue:
Product			68.3	%			70.5	%			69.9	%			71.6	%
Service and other			31.7				29.5				30.1				28.4
Total revenue			100.0				100.0				100.0				100.0
Cost of revenue:
Product			37.2				40.1				34.8				37.5
Service and other			46.7				49.6				41.1				48.7
Total cost of revenue			83.9				89.7				75.9				86.2
Gross profit			16.1				10.3				24.1				13.8
Operating expenses:
Research and development			18.9				21.0				18.6				18.9
Selling, general and administrative			33.0				36.3				28.0				32.4
Total operating expenses			51.9				57.3				46.6				51.3
Loss from operations			(35.8	)			(46.9	)			(22.5	)			(37.5	)
Other income (expense)			4.3				2.0				1.3				1.6
Loss before income tax			(31.5	)			(44.9	)			(21.2	)			(35.9	)
Income tax expense (benefit)			0.1				0.7				0.0				(0.1	)
Net loss			(31.6)	%			(45.6	)%			(21.2)	%			(35.8	)%

Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009

Revenue

Revenue by major type was as follows (in thousands):

		Three Months Ended September 30,
		2010								2009
Product revenue		$	29,759				68.3	%		$	24,252				70.5	%
Service and other revenue			13,823				31.7				10,126				29.5
		$	43,582				100.0	%		$	34,378				100.0	%

Revenue by geographic region was as follows (in thousands):

		Three Months Ended September 30,
		2010								2009
Americas (1)		$	16,627				38.2	%		$	24,567				71.5	%
Europe and Middle East			15,607				35.8				1,670				4.9
Asia-Pacific			11,348				26.0				8,141				23.7
		$	43,582				100.0	%		$	34,378				100.0	%

Product revenue increased $5.5 million, or 23%, between periods. This increase was primarily due to a higher average selling price of Systems installed and accepted and an increase in options revenue during the three months ended September 30, 2010 versus the three months ended September 30, 2009.

Service and other revenue increased $3.7 million, or 37%, between periods. This increase was primarily attributable to an increase in service contract revenue, as Systems moved from warranty to service contract coverage. There were 30% more units covered by service contracts at September 30, 2010 as compared to September 30, 2009.

Cost of revenue

Cost of revenue increased to $36.6 million for the three months ended September 30, 2010 from $30.8 million for the three months ended September 30, 2009, an increase of $5.8 million, or 19%. Overall, our gross profit was 16.1% for the three months ended September 30, 2010 compared to 10.3% for the three months ended September 30, 2009.

Total product costs increased by $2.5 million, or 18%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase is primarily due to an increase in options sold and a TomoMobile system sale, which had a higher cost due to the inclusion of the relocatable coach.

Total service and other costs increased by $3.3 million, or 19%, for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. The increase was due to a 30% increase in the number of units under service. In addition, we experienced a higher rate of component part failures in the three months ended September 30, 2010 as compared to the three months ended September 30, 2009. Service margins have improved year over year due to a reduction in employee and other service support costs per contract.

Warranty expenses increased $0.6 million for the three months ended September 30, 2010 compared to the three months ended September 30, 2009 due to an increase in the amount of warranty services provided under warranty agreements.

Research and development expenses

Research and development expenses by category for the three months ended September 30, 2010 and 2009 were as follows (in thousands):

		Three Months Ended September 30,
		2010				2009				$ Change				% Change
System R&D		$	6,855			$	5,473			$	1,382				25.3	%
Proton Project / CPAC R&D			1,373				1,745				(372	)			(21.3	)
		$	8,228			$	7,218			$	1,010				14.0	%

Total research and development expenses increased $1.0 million, or 14%, between periods. System research and development expenses increased by $1.4 million between periods primarily due to a $1.0 million decrease in capitalized internal development costs in the three months ended September 30, 2010 as compared to the three months ended September 30, 2009, and also due to an increase in consulting costs. The proton therapy research project spending decreased by $0.4 million during the three months ended September 30, 2010, due mainly to a decrease in consulting costs.

Selling, general and administrative expenses

Selling, general and administrative expenses increased to $14.4 million for the three months ended September 30, 2010 from $12.5 million for the three months ended September 30, 2009, representing an increase of $1.9 million, or 15%. The increase was due primarily to a $0.7 million increase in outside services, a $0.7 million increase in employee costs, a $0.6 million increase in the allowance for doubtful accounts and a $0.5 million increase in CPAC spending in the third quarter of 2010. These increases were partially offset by a $1.0 million decrease in commissions in the third quarter of 2010 as compared to the third quarter of 2009.

Other income (expense)

We had other income of $1.9 million and $0.7 million for the three months ended September 30, 2010 and 2009, respectively. The increase of approximately $1.2 million was attributable to a $1.4 million increase in other income (expense) in the third quarter of 2010 compared with the three months ended September 30, 2009, due primarily to the impact of foreign currency exchange rates. Partially offsetting this increase was a $0.3 million decrease in interest income, as our average investment balances and interest rates were lower during the third quarter of 2010 as compared to the third quarter of 2009.

Income tax expense (benefit)

For the three months ended September 30, 2010, we recorded income tax expense of $0.05 million resulting in an effective income tax rate of (0.3)%. Our effective tax rate for the third quarter differed significantly from the statutory tax rate primarily due to maintaining a valuation allowance for deferred tax assets in domestic and certain foreign taxing jurisdictions that do not satisfy the more-likely-than-not realization threshold. For the three months ended September 30, 2009, we recorded an income tax expense of $0.3 million resulting in an effective income tax rate of (1.7)%.

Nine Months Ended September 30, 2010 Compared to Nine Months Ended September 30, 2009

Revenue

Revenue by major type was as follows (in thousands):

		Nine Months Ended September 30,
		2010								2009
Product revenue		$	93,230				69.9	%		$	75,937				71.6	%
Service and other revenue			40,062				30.1				30,144				28.4
		$	133,292				100.0	%		$	106,081				100.0	%

Revenue by geographic region was as follows (in thousands):

		Nine Months Ended September 30,
		2010								2009
Americas (1)		$	56,283				42.2	%		$	68,171				64.3	%
Europe and Middle East			51,171				38.4				20,258				19.1
Asia-Pacific			25,838				19.4				17,652				16.6
		$	133,292				100.0	%		$	106,081				100.0	%

Product revenue increased $17.3 million, or 23%, between periods. This increase was attributable to 19% more Systems installed and accepted during the nine months ended September 30, 2010 versus the nine months ended September 30, 2009. Additionally, average System selling prices during the first nine months of 2010 increased 1% from selling prices during the first nine months of 2009.

Service and other revenue increased $9.9 million, or 33%, between periods. This increase was primarily attributable to an increase in service contract revenue, as more Systems moved from warranty to service contract coverage. There were 30% more units covered by service contracts at September 30, 2010 as compared to September 30, 2009.

Cost of revenue

Cost of revenue increased to $101.2 million for the nine months ended September 30, 2010 from $91.5 million for the nine months ended September 30, 2009, an increase of $9.8 million, or 11%. The increase in cost of revenue was primarily due to higher product costs related to more Systems being installed and accepted. Overall, our gross profit was 24.1% for the nine months ended September 30, 2010 compared to 13.8% for the nine months ended September 30, 2009. The increase in our gross profit percentage for the first nine months of 2010 was the result of higher System volume and improved service margin.

Product costs increased by $6.6 million, or 17%, for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. This increase was primarily due to higher System volume. While total product costs increased, margins improved due to better leverage of fixed costs.

Total service and other costs increased by $3.2 million for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009. The increase was due to a 30% increase in the number of units under service contract at September 30, 2010 as compared to September 30, 2009. Service margins have improved year over year due to a reduction in employee and other service support costs per contract.

Warranty expenses increased $1.0 million for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 due an increase in the amount of warranty services provided under warranty agreements.

Research and development expenses

Research and development expenses by category were as follows (in thousands):

		Nine Months Ended September 30,
		2010				2009				$ Change				% Change
System R&D		$	21,059			$	16,406			$	4,653				28.4	%
Proton Project / CPAC R&D			3,669				3,680				(11	)			(0.3	)
		$	24,728			$	20,086			$	4,642				23.1	%

Total research and development expenses increased $4.6 million, or 23%, between periods. System research and development activities increased by $4.7 million primarily due to a $2.8 million decrease in capitalized internal development costs, a $0.9 million increase in employee costs and a $1.2 million increase in consulting expense for the nine months ended September 30, 2010 as compared to the same period in 2009. The proton therapy research project spending remained flat during the first nine months of 2010.

Selling, general and administrative expenses

Selling, general and administrative expenses increased to $37.3 million for the nine months ended September 30, 2010 from $34.3 million for the nine months ended September 30, 2009, an increase of $3.0 million, or 9%. The increase was primarily due to a $1.5 million increase in employee costs, a $0.8 million increase in trade show expenses, a $0.7 million increase in CPAC spending, a $0.7 million increase in the allowance for doubtful accounts and a $0.4 million increase in legal fees. These increases were partially offset by a $0.5 million decrease in commissions and a $1.1 million decrease in sales concessions in the first nine months of 2010 compared to the first nine months of 2009.

Other income (expense)

We had other income of $1.8 million and $1.7 million for the nine months ended September 30, 2010 and 2009, respectively. The $0.1 million increase was primarily due to the impact from foreign currency exchange rates, partially offset by a $0.7 million decrease in interest income as our investment balances and interest rates were lower during the first nine months of 2010 than during the same period in 2009.

Income tax expense (benefit)

For the nine months ended September 30, 2010, we recorded an income tax expense of $0.01 million resulting in an effective income tax rate of (0.05)%. The effective tax rate for the nine months ended September 30, 2010 differed significantly from the statutory tax rate primarily due to maintaining a valuation allowance for deferred tax assets in domestic and certain foreign taxing jurisdictions that do not satisfy the more-likely-than-not realization threshold. For the nine months ended September 30, 2009, we recorded an income tax benefit of $0.2 million resulting in an effective income tax rate of 0.4%.

Liquidity and Capital Resources

To date, we have funded our working capital and capital expenditure requirements using cash generated from sales of equity securities and, to a lesser extent, borrowings. From our inception through September 30, 2010, we obtained financing of $236.0 million primarily through public and private placements of equity securities and the exercise of stock options.

Financial Condition

Our cash and cash equivalents and short-term investments were $140.0 million at September 30, 2010 compared to $154.3 million at December 31, 2009, a decrease of $14.3 million, or 9%. Information regarding short-term investments, which totaled $29.6 million at September 30, 2010, is set forth in Note C to the condensed consolidated financial statements.

We entered into a revolving credit facility during 2009, under which there were no borrowings as of September 30, 2010. This line of credit expires on November 30, 2010. The facility requires us to maintain a minimum tangible net worth, a specified ratio of total liabilities to tangible net worth and a minimum level of cash and short-term investments. We were in compliance with these covenants at September 30, 2010. In addition, the facility provides for an adjusted credit limit based on a certain level of tangible net worth and earnings before interest, taxes, depreciation and amortization. Based on our levels as of September 30, 2010, the adjusted credit limit is $30 million. Under the terms of the credit facility, we may be considered in default upon a material adverse change in our financial condition or if the bank believes the prospect of payment or performance of the facility is impaired.

Our working capital, which is calculated by subtracting our current liabilities from our current assets, was $142.5 million at September 30, 2010 compared to $161.8 million at December 31, 2009, a decrease of approximately $19.2 million, or 12%. Our shareholders’ equity was $166.0 million at September 30, 2010 compared to $183.4 million at December 31, 2009, a decrease of approximately $17.5 million, or 10%. The decrease in both our working capital and shareholders’ equity was primarily due to our operating loss during the first nine months of 2010.

Net cash used in operating activities was $15.5 million and $9.3 million for the nine months ended September 30, 2010 and 2009, respectively. Driving cash flows from operations were net losses in the nine months ended September 30, 2010 of $28.2 million, partially offset by the effect of non-cash expenses such as depreciation, amortization and share-based compensation expense of $13.4 million. Also contributing to the net use of cash were changes in operating assets and liabilities, which resulted in a net use of cash of $0.7 million for the first nine months of 2010. For the nine months ended September 30, 2009, the cash impact of our net loss of $38.0 million was reduced by non-cash items that totaled $12.4 million and changes in operating assets and liabilities of $16.3 million.

Net cash provided by investing activities was $43.3 million and $5.1 million for the nine months ended September 30, 2010 and 2009, respectively. Cash expended for additions of property and equipment was $3.6 million in the first nine months of 2010 versus $1.7 million in the first nine months of 2009. Net cash proceeds from the purchases and sales and maturities of short-term investments were $47.8 million in the first nine months of 2010 versus $9.9 million in the first nine months of 2009.

Net cash provided by financing activities was $7.3 million and $6.8 million for the nine months ended September 30, 2010 and 2009, respectively. The increase in cash provided by financing activities for the nine months ended September 30, 2010 was due primarily to proceeds from the exercises of stock options and warrants.

Loans and Available Borrowings

There have been no significant changes to the loans and available borrowings we reported in our Annual Report on Form 10-K for the year ended December 31, 2009.

Contractual Obligations and Commitments

There have been no significant changes to the contractual obligations and commitments we reported in our Annual Report on Form 10-K for the year ended December 31, 2009.

Pending Litigation and Reserve for Contingency

See Note G to the condensed consolidated financial statements.

Operating Capital and Capital Expenditure Requirements

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

	•		Revenue generated from sales of the System and service contracts;
	•		The performance of the System operating in the field and corresponding service costs;
	•		The level of investment required by our service and support organization;
	•		The level of investment required for research and development activities;
	•		Costs associated with our manufacturing, sales and marketing and general and administrative activities; and
	•		Effects of competing technological and market developments.

The global economy remains volatile and could have potentially negative effects on our near-term liquidity and capital resources, including slower collection of receivables, delays in the delivery of existing orders and postponements of incoming orders. However, we believe that our cash and short-term investments as of September 30, 2010, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. As of September 30, 2010, we had $140.0 million of cash and short-term investments. We do not expect to draw on our $30 million line of credit, and we believe our financial position will remain strong through the remainder of 2010 and 2011. Moreover, we continue to manage our cash resources and are carefully monitoring our ongoing expenditures.

Off-Balance Sheet Arrangements

We have no off balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

Critical Accounting Policies and Estimates

For a description of our critical accounting policies and estimates, please refer to the “Critical Accounting Policies and Estimates” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 3.		Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk is currently confined to changes in short-term investments, foreign currency exchange and interest rates. Our exposure to market risk was discussed in “Item 7A. Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the year ended December 31, 2009. There have been no material changes since December 31, 2009.

Item 4.		Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2010.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II. OTHER INFORMATION

Item 1.		Legal Proceedings

We are subject to various claims and legal proceedings arising in the ordinary course of our business. The description of the developments with respect to the pending securities litigation and the two pending derivative suits (and similar demand letters) is incorporated herein by reference to Note G to our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. We believe that the ultimate resolution of the various claims and legal proceedings to which we are subject will not have a material adverse effect on our business, financial condition or results of operations.

Item 1A.		Risk Factors

In addition to the risk factors set forth below and the other information set forth in this report, you should carefully consider the factors discussed in “Part I, Item 1A. Risk Factors” in our 2009 Annual Report on Form 10-K and in “Part II, Item 1A. Risk factors” in our Quarterly Reports on Form 10-Q for the periods ended March 31, 2010 and June 30, 2010, which could materially affect our business, financial condition or results of operations. Important factors that could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by statements in this Quarterly Report on Form 10-Q include, but are not limited to, the risk factors discussed below or in “Part I, Item 1A. Risk Factors” in our 2009 Annual Report on Form 10-K or in Part II, Item IA. Risk factors” in our Quarterly Reports on Form 10-Q for the periods ended March 31, 2010 and June 30, 2010. If any of the events discussed in such risk factors occur, our business, financial condition and results of operations could be materially adversely affected, and the market value of our common stock could decline.

Our ability to increase our profitability depends in part on reducing our warranty and service costs for the TomoTherapy treatment systems and improving our economies of scale in service operations, which we may not be able to achieve.

Our overall service operations currently are not profitable. Moreover, our gross margins may decline in a given period due in part to significant replacement rates for components, resulting in increased warranty expense, negative profit margins on service contracts and customer dissatisfaction. We are implementing a number of improvements to our service processes, which might reduce costs. We also are developing alternate components and identifying lower priced components of comparable or improved performance and quality. However, there is no assurance that these initiatives will be successful. If we are unable to reduce our expenses and improve quality and reliability through these initiatives, our profitability may not improve or may be materially adversely affected, particularly given the increased percentage of our revenue attributable to service contracts. Our distributors that provide warranty and service support on Systems they have sold in their geographic region may also experience an adverse impact on their profitability, which may increase our cost to service Systems in those regions. Additionally, we may face increased claims of compensation from customers who are not satisfied with the quality and reliability of our products, which could increase our service costs and negatively affect future product sales. Even if we are able to implement these cost reduction and quality improvement efforts successfully, our service operations may remain unprofitable given the relatively small size and geographic dispersion of our installed base, which prevents us from achieving significant economies of scale for the provision of services.

In April 2008, we invested in the continued development of a new compact proton therapy system through a separate entity, Compact Particle Acceleration Corporation (CPAC). Our business, results of operations and financial condition will be adversely affected if CPAC is unable to obtain additional funding or if CPAC otherwise fails to successfully develop and commercialize this technology.

In April 2008, we announced our participation in CPAC, to continue development of our research initiative for a compact proton therapy system for the treatment of cancer. CPAC has and is continuing to seek investments from third parties to support development of this technology. We retain the option to purchase a portion of the CPAC stock held by CPAC investors in exchange for the right to commercialize the technology in the medical field, with the right first exercisable at the end of April 2010 and at any time thereafter through 2015. CPAC needs additional funding to continue its development efforts. We cannot be certain that CPAC will be able to obtain all of the additional financing required for this project on commercially reasonable terms or that the technology development will be successful, any of which could limit our ability to grow and diversify our product portfolio. Even if CPAC is able to obtain financing and the technology development is successful, CPAC may not have the resources to commercialize the compact proton system, the market requirements may change such that commercialization is no longer feasible, or we may not be in a position to finance our call right. If we do not exercise our call right and CPAC is unable to obtain additional financing, our reputation as an initial investor in CPAC may be impaired and other investors in CPAC may be dissatisfied. Moreover, if we are unable to diversify our business through the addition of a proton therapy product, we will continue to rely on a single product line for substantially all of our revenue, including all of the risks and fluctuations in revenue or profitability resulting from such reliance.

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

(a) Recent Sales of Unregistered Securities

None.

(b) Use of Proceeds from Public Offering of Common Stock

Our initial public offering of 13,504,933 shares of our common stock, par value $0.01 per share, was effected through a Registration Statement on Form S-1 (Reg. No. 333-140600), which was declared effective by the Securities and Exchange Commission on May 8, 2007. We issued 10,602,960 shares on May 9, 2007 and received gross proceeds of $201.5 million. We paid the underwriters a commission of $14.1 million and incurred additional offering expenses of approximately $2.7 million. After deducting the underwriters’ commission and the offering expenses, we received net proceeds of approximately $184.7 million. The managing underwriter of our initial public offering was Merrill Lynch & Co. In addition, 2,901,973 shares were sold by selling shareholders, 1,761,513 of which were purchased by the underwriters’ exercise of their overallotment option.

No payments of underwriters’ commissions or offering expenses were made directly or indirectly to (i) any of our directors, officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity securities, or (iii) any of our affiliates.

Through September 30, 2010, we had used $102.1 million of the net proceeds from our initial public offering, as detailed in the following table (in millions):

Working capital		$	74.9
Purchases of property and equipment			19.6
Purchases of test systems			5.7
Acquisition of Chengdu Twin Peak Accelerator Technology Inc.			1.5
Repayment of debt			0.4
Total net proceeds used		$	102.1

(c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

Item 6.		Exhibits

Exhibit Number					Description
	3.1	(1)			Amended and Restated Articles of Incorporation of the Company
	3.2	(1)			Amended and Restated Bylaws of the Company
	10.1	(2)†			Amendment to Supply Agreement, dated September 9, 2010, between the Company and Hitachi Medical Corporation
	31.1	*			Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	*			Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	*			Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.2	*			Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, TomoTherapy Incorporated has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EXHIBIT INDEX

Exhibit Number					Description
	3.1	(1)			Amended and Restated Articles of Incorporation of the Company
	3.2	(1)			Amended and Restated Bylaws of the Company
	10.1	(2)†			Amendment to Supply Agreement, dated September 9, 2010, between the Company and Hitachi Medical Corporation
	31.1	*			Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	*			Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	*			Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.2	*			Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002