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 developed, market and sell the Hi Art system, an advanced and versatile radiation therapy system for the treatment of a wide variety of cancers. The Hi Art system combines integrated CT imaging with radiation therapy to deliver radiation treatment with speed and precision while reducing radiation exposure to surrounding healthy tissue which, we believe, can lead to improved patient outcomes. We market and sell the system to hospitals and cancer treatment centers in North America, Europe, the Middle East and Asia-Pacific and offer customer support services in each region either directly or through distributors.
For the six months ended June 30, 2009 and 2008, our revenue was $71.7 million and $90.9 million, respectively, a decrease of 21%. Our net loss attributable to shareholders for the six months ended June 30, 2009 and 2008 was $20.1 million and $13.0 million, respectively, an increase of 54%. The decreased profitability in 2009 was primarily caused by the sale of 35% fewer Hi Art systems than last year and our inability to record a federal tax benefit due to the need for a full valuation allowance on our net deferred tax assets. The amount of U.S. federal income tax benefit recorded during the first six months of 2008 was $5.5 million, or $0.11 per share. Although our revenue decreased compared to the first six months of 2008 and we experienced a net loss, we maintained a working capital balance of $173 million, including $149 million of cash and short-term investments as of June 30, 2009. Thus, we believe we are able to fund ongoing operations and invest in future product offerings for at least the next 12 months.
Despite near-term economic challenges, we remain confident in the future commercial demand for our technology and product offering due to our current backlog of $145 million, increasing service revenue, planned future product enhancements and anticipated growth in demand for image-guided radiation therapy equipment.
Factors Affecting Our Financial Performance Our financial performance is significantly affected by the following factors:
Incoming Orders
Since we sell high-priced capital equipment with a long sales cycle 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 six months of 2009, we experienced a decline in incoming orders as compared to the first six months of 2008. We believe that this decline resulted from a combination of the current global economic downturn, the ongoing credit crisis, our transition in sales leadership and increased competitive pressure.

Since the Hi Art system is a major capital expenditure, our customers may require funding through a credit facility or lease arrangement. In the current economic environment, many customers are having increased 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. In the first six months of 2009, some orders we expected to close have not been placed, which we believe might be the result of concerns about economic conditions or difficulty obtaining financing. Since the beginning of 2008, we have experienced increased competition in the marketplace. To counter this, we continue working to increase our sales competitiveness by improving the quality and effectiveness of our sales force, increasing our focus on group purchasing organizations and national accounts, increasing our emphasis on regional user meetings and expanding product features, as evidenced by our previously announced plans to launch TomoDirect software, in order to open greater market opportunities. 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 resume our revenue growth.
During 2008, we terminated the distribution agreement with our former Japanese distributor, resulting in a stoppage of incoming orders from Japan. Effective January 1, 2009, we entered into a distributorship agreement with Hitachi Medical Corporation (Hitachi) to distribute the Hi Art system in Japan. Japan is the second largest market in the world for radiation therapy equipment. We believe Hitachi's knowledge of the radiation therapy market will help us regain our momentum in this important market.
Backlog
As of June 30, 2009, we had a backlog of $145 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 Hi Art system and related options that we believe are likely to ship within 24 months. To be included in backlog, such orders must be evidenced by a signed quotation or purchase order from the customer. 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 do not meet our backlog definition, we remove the orders from our backlog.
Revenue
The majority of our revenue is generated from sales of the Hi Art system. We negotiate the actual purchase price with each customer, and, historically, the purchase price has varied significantly across geographic regions. Because of global economic conditions and increased competition in 2009, we expect our 2009 revenue to be lower than our 2008 revenue. However, based on anticipated continued growth in market demand for image-guided radiation therapy equipment, our new senior sales management, our growing number of service contracts, our revenue backlog and our expected release of product enhancements in the future, we remain confident in the future commercial demand for our technology and product offering.
Our revenue projections can be impacted by a number of factors, including the following:
• The majority of our Hi Art system shipments generally occur 9 to 12 months after we receive the order. Timing of deliveries can be affected by factors out of our control such as construction delays at customer project sites and customer credit issues. We generally recognize revenue from a system sale upon customer acceptance, which usually occurs three to four weeks after delivery. Each installation represents a significant percentage of our revenue for the period in which it occurs.

• Our geographic mix of customers may impact our average selling prices. Increased sales of the Hi Art system outside of North America have tended to favorably impact our gross margins due to higher average selling prices in these markets. We intend to continue to expand our international selling efforts, although we cannot be certain that favorable pricing trends will continue nor can we 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 Hi Art system compared to competing systems is a factor in our ability to increase market demand for the Hi Art system. To compete effectively, we may need to offer additional features that could require substantial internal resources to develop.

• Our focus on sales to for-profit, multi-center customers in the United States may require us to lower selling prices, as these customers have negotiated quantity discounts. In addition, we have a limited history of working with these for-profit, multi-center customers. 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 Hi Art system is a major capital equipment item that represents a significant purchase for most of our customers. If the global economy does not improve, our customers 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 Hi Art system. As a result, our incoming orders and subsequent revenue recognition may be materially adversely affected.

Also included in our revenue are sales of optional equipment and software enhancements purchased by our end customers. Because we plan to further develop the Hi Art system by adding upgraded features, we expect to experience continued revenue growth from sales of optional equipment and software enhancements. Service revenue. Our service revenue is generated primarily from post-warranty service contracts and the sale of service spare parts. Our service contracts may be purchased with one-year or multiple-year terms and for a variety of service levels, giving our customers the option to contract for the level of support they desire. As of June 30, 2009, our most popular service plan was our Total TLC Service Package, or Total TLC. Under Total TLC, we provide customers with full spare parts coverage, including installation service by our field service engineers, and full planned maintenance. We recognize service contract revenue ratably over the term of the contract. We recognize revenue from spare parts, which are primarily sold to our distributors, upon shipment. As the number of installed Hi Art systems continues to grow, we expect to experience growth in our revenue from post-warranty service contracts.
Our ability to execute our strategies to increase incoming orders, to increase backlog with high quality orders, to increase sales of optional equipment and software enhancements and to grow our service revenue will have a direct impact on our ability to increase overall revenue in the future. If we are unable to successfully execute these strategies, we may generate revenue at levels that are lower than those we have generated in the past. Cost of revenue
Cost of revenue includes all of our manufacturing and service costs. It consists of material, labor and overhead costs incurred in the manufacture of the Hi Art system. It also includes the cost of shipping the system to the customer site, installation costs, warranty provision and royalty payments to Wisconsin Alumni Research Foundation (WARF), one of our shareholders. Finally, cost of revenue includes the customer support and service infrastructure required to service and repair the Hi Art system during the warranty and service contract periods. In future periods, we expect to improve our gross margins through the following initiatives:
• Component supply and cost. Our cost of revenue continues to be impacted by high component costs and high replacement rates. We continue to develop alternate components and implement enhancements to increase the performance of components used in the Hi Art 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 Hi Art 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.

• Service and support expenses. We have a declining number of individual service contracts that produce negative gross profit margins for which we have recorded a reserve for the related estimated future losses. However, our overall average direct service costs per installed system continues to decrease. We expect to continue to improve service contract margins by leveraging our service infrastructure costs over a larger installed base, increasing the price for some of our older annual service contracts, training our personnel to improve their problem-solving capabilities, implementing remote diagnostic functionalities and introducing component design changes. In addition, we believe that achieving certain of these initiatives should also lead to reduced warranty costs and improved system performance.

Our ability to execute on these strategies to reduce customer support and service 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 performance. Operating expenses
We expect research and development expenses to decrease during 2009, both in dollars and as a percentage of total revenue, as we have decreased the total number of employees performing research and development activities. In addition, we believe we are being more selective with our ongoing project spending by focusing on the highest priority projects. Furthermore, during 2009, we expect to continue to capitalize software development costs in accordance with Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (SFAS No. 86). We expect 2009 selling, general and administrative expenses to approximate such expenses in 2008, both in dollars and as a percentage of total revenue. In future years, we expect these expenses to decrease as a percentage of total revenue as our overall business grows.
Nonoperating expenses
Because we conduct business in numerous foreign jurisdictions, we are exposed to changes in foreign currency exchange rates. Foreign currency exchange rate fluctuations could materially adversely affect our business, financial condition and results of operations. Our primary exposures are related to foreign currency denominated sales and expenses in Europe. As of June 30, 2009, we did not have a hedging program in place to offset these risks. Interest income
Since the completion of our initial public offering, we have invested our cash balances in a short-term investment portfolio. Until recently, this has led to growing interest income. We expect interest income to decline in 2009 due both to lower levels of investable cash and to a reduction in interest rates. Income tax expense (benefit)
We are subject to taxation in the United States and in numerous foreign jurisdictions. Significant judgments and estimates are required when evaluating our tax positions and determining our worldwide provision for income taxes. As a result, our effective tax rate may fluctuate based on a number of factors including variations in projected taxable income in the numerous geographic locations in which we operate, changes in the valuation of our deferred tax assets, tax positions taken on tax returns filed in the geographic locations in which we operate, introduction of new accounting standards and changes in tax liabilities to address potential tax exposures related to business and income tax positions we have taken that could be challenged by taxing authorities. Valuation allowances are established when necessary to reduce deferred tax assets to the amount more-likely-than-not to be realized under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109). SFAS No. 109 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 six months of 2009 included the existence of cumulative three-year losses, a decreased backlog, projected current year losses and the impact of current economic conditions. Noncontrolling interests
Our condensed consolidated financial statements include the accounts of Compact Particle Acceleration Corporation (CPAC), our controlled, minority-owned affiliate. We hold a call option on certain medical technology of CPAC and maintain overall control of CPAC's board of directors. As a result, for accounting purposes, we have a controlling interest in the entity. Since our ownership interest is less than 50%, the outside stockholders' interests are shown in our condensed consolidated financial statements as "Noncontrolling interests." If we obtain additional third-party funding we are seeking for CPAC, 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 June 30,            Six Months Ended June 30,
                                           2009                2008               2009               2008
Revenue                                        100.0 %             100.0 %           100.0 %            100.0 %
Cost of revenue                                 79.2                75.9              84.6               77.2

Gross profit                                    20.8                24.1              15.4               22.8

Operating expenses:
Research and development                        17.1                19.3              18.0               21.5
Selling, general and administrative             27.4                26.2              30.5               26.7

Total operating expenses                        44.5                45.5              48.5               48.2

Loss from operations                           -23.7               -21.4             -33.1              -25.4
Other income                                     1.4                 1.9               1.4                3.0

Loss before income tax and
noncontrolling interests                       -22.3               -19.5             -31.7              -22.4
Income tax benefit                              -0.8                -3.5              -0.6               -6.5

Net loss                                       -21.5               -16.0             -31.1              -15.9
Noncontrolling interests                         4.2                 2.9               3.0                1.6

Net loss attributable to
shareholders                                   -17.3 %             -13.1 %           -28.1 %            -14.3 %

Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008
Revenue
Revenue by major type for the three months ended June 30, 2009 and 2008 was as
follows (in thousands except for percentages):

                                               Three Months Ended June 30,
                                               2009                   2008
            Product revenue             $ 30,552        74 %   $ 45,247        87 %
            Service and other revenue     10,528        26        6,774        13

                                        $ 41,080       100 %   $ 52,021       100 %

Revenue by geographic region for the three months ended June 30, 2009 and 2008 was as follows (in thousands except for percentages):

                                              Three Months Ended June 30,
                                              2009                   2008
              North America            $ 25,365        62 %   $ 32,822        63 %
              Europe and Middle East     12,313        30       10,911        21
              Asia-Pacific                3,402         8        8,288        16

                                       $ 41,080       100 %   $ 52,021       100 %

Product revenue decreased $14.7 million or 32% between periods. This decrease was attributable to 33% fewer Hi Art systems installed and accepted during the three months ended June 30, 2009 versus the three months ended June 30, 2008. Overall, average selling prices of the Hi Art system during the second quarter of 2009 decreased 2% from those of the second quarter of 2008.
Service and other revenue increased $3.8 million or 55% 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 54% more units covered by service contracts at June 30, 2009 as compared to June 30, 2008.

Cost of revenue
Cost of revenue decreased to $32.6 million for the three months ended June 30, 2009 from $39.5 million for the three months ended June 30, 2008, a decrease of $6.9 million or 18%. The reduction in cost of revenue was primarily due to lower product costs related to fewer Hi Art systems installed and accepted. Overall, our gross margin was 20.7% for the three months ended June 30, 2009 compared to 24.1% for the three months ended June 30, 2008.
Manufacturing period expenses increased by $0.9 million for the three months ended June 30, 2009 as compared to the three months ended June 30, 2008. This increase was primarily due to our decision to slow manufacturing activity during the period, which led to an increase in unabsorbed costs.
Total service and support costs decreased by $0.9 million for the three months ended June 30, 2009 compared to the three months ended June 30, 2008. Although there was a $4.1 million increase in our overall service contract costs during the second quarter of 2009 due to the larger number of units under service contract at June 30, 2009 as compared to June 30, 2008, such increase was more than offset by factors including (a) a $3.4 million decline in service infrastructure costs, as travel and overtime expenses decreased $1.6 million due to a lower number of service repair interventions to our installed base and costs associated with component and software upgrades to the installed base decreased $1.3 million, (b) a $0.9 decrease in costs related to the sale of spare parts, as several of our distributors that had requested additional inventory during the second quarter of 2008 did not do so during the second quarter of 2009 and (c) a $0.7 million decrease in our contract loss provision due to a decline in the number of individual service contracts generating negative gross profit margins.
Warranty expenses decreased $2.2 million for the three months ended June 30, 2009 compared to the three months ended June 30, 2008 due to improved overall performance of our installed systems.
Research and development expenses
Research and development expenses by category for the three months ended June 30, 2009 and 2008 were as follows (in thousands except for percentages):

                                               Three Months Ended June 30,
                                     2009         2008       $ Change       % Change
        Hi Art R&D                  $ 5,353     $  8,366     $  (3,013 )        -36.0 %
        Proton Project / CPAC R&D     1,667        1,678           (11 )         -0.7

                                    $ 7,020     $ 10,044     $  (3,024 )        -30.1 %

Total research and development expenses decreased $3.0 million or 30% between periods. Hi Art research and development activities decreased by $3.0 million between periods primarily due to a $1.4 million decrease in project spending, as we were more selective with our spending by focusing on high priority projects, and a $0.5 million decrease in employee costs, as fewer employees were engaged in research and development activities. We also capitalized internal development costs of $1.0 million during the second quarter of 2009 related to certain software options under development compared to $0.1 million in the second quarter of 2008.
Selling, general and administrative expenses Selling, general and administrative expenses decreased to $11.2 million for the three months ended June 30, 2009 from $13.6 million for the three months ended June 30, 2008, a decrease of $2.4 million or 18%. The decrease was primarily due to a $2.7 million reserve for doubtful accounts receivable recorded during the second quarter of 2008 and a $1.6 million decrease in commissions payable due to the lower volume of Hi Art systems ordered or accepted during the period. These decreases were partially offset by a $0.7 million increase in employee costs, as we reversed a compensation-related expense provision during the second quarter of 2008, and a $0.6 million increase in selling costs due to resolutions of customer disputes.

Other income (expense)
Other income decreased to $0.6 million for the three months ended June 30, 2009 from $1.0 million for the three months ended June 30, 2008, a decrease of $0.4 million or 43%. The decrease was primarily due to a $0.4 million decrease in interest income, as our investment balances and interest rates were significantly lower during the second quarter of 2009 than in 2008. Income tax expense
For the three months ended June 30, 2009, we recorded an income tax benefit of $0.3 million resulting in an effective income tax rate of 4%. The effective tax rate for the second quarter of 2009 differed significantly from the statutory tax rate primarily due to recording a valuation allowance for deferred tax assets in domestic and certain foreign taxing jurisdictions that are not more-likely-than-not to be realized. For the three months ended June 30, 2008, we recorded an income tax benefit of $1.8 million resulting in an effective income tax rate of 22%.
Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008 Revenue
Revenue by major type for the six months ended June 30, 2009 and 2008 was as follows (in thousands except for percentages):

. . .