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Annual Report 2008

Plain-text annual report

QuickLinks -- Click here to rapidly navigate through this documentUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K(MarkOne)  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACTOF 1934.For the fiscal year ended June 28, 2008o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGEACT OF 1934.For the transition period from to .Commission file number 001-33301ACCURAY INCORPORATED(Exact Name of Registrant as Specified in Its Charter)DELAWARE(State or Other Jurisdiction ofIncorporation or organization) 20-8370041(I.R.S. Employer Identification No.)1310 Chesapeake TerraceSunnyvale, California 94089(Address of Principal Executive Offices) (Zip Code)Registrants' telephone number, including area code: (408)716-4600Securities registered pursuant to section 12(b) of the Act:Title of Each Class Name of Each Exchange on Which RegisteredCommon stock, $.001 Par Value Per Share The NASDAQ Stock Market LLCSecurities registered pursuant to section 12(g) of the Act:None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No  Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No  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 of1934 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 suchfiling requirements for the past 90 days. Yes  No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained,to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Checkone):Large accelerated filer o Accelerated filer  Non-accelerated filer o(Do not check if a smaller reporting company) Smaller reporting company o Indicate by check mark whether the registrant is a Shell Company (as defined in Rule12b-2 of the Exchange Act). Yes o No  The aggregate market value of the registrant's common stock held by non-affiliates of the registrant based on the last sale price for such stock onDecember 29, 2007: $655,096,455. As of August 29, 2008, the number of outstanding shares of the registrant's common stock, $0.001 par value, was 54,629,296.DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Registrant's 2008 Annual Meeting of stockholders are incorporated by reference in Part III of thisForm 10-K.ACCURAY INCORPORATED YEAR ENDED JUNE 28, 2008 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS PART I Item 1. Business 1 Item 1A. Risk Factors 27 Item 1B. Unresolved Staff Comments 48 Item 2. Properties 48 Item 3. Legal Proceedings 48 Item 4. Submission of Matters to a Vote of Security Holders 48 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 49 Item 6. Selected Financial Data 52 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 54 Item 7A. Quantitative and Qualitative Disclosure About Market Risk 77 Item 8. Financial Statements and Supplementary Data 78 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 116 Item 9A. Controls and Procedures 116 Item 9B. Other Information 119 PART III Item 10. Directors, Executive Officers and Corporate Governance 120 Item 11. Executive Compensation 120 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 120 Item 13. Certain Relationships and Related Transactions, and Director Independence 121 Item 14. Principal Accountant Fees and Services 121 Item 15. Exhibits and Financial Statement Schedules 121 Signatures 125 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. We have basedthese forward-looking statements largely on our current expectations and projections about future events and financial trends affecting the financialcondition of our business. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily beaccurate indications of the times at, or by, which such performance or results will be achieved. Factors that could cause our actual results to differmaterially include those discussed under "Risk Factors" in Part I, Item 1A of this report. We undertake no obligation to update or revise any forward-looking statements to reflect any event or circumstance that arises after the date of this report.PART I Our fiscal year ends on the Saturday closest to June 30th, so that in a 52 week period, each fiscal quarter consists of 13 weeks. The additionalweek in a 53 week year is added to the fourth quarter, making such quarter consist of 14 weeks. Fiscal years 2008, 2007 and 2006 are each comprisedof 52 weeks. For ease of presentation purposes, we refer to June 30 as the Company's fiscal year end.Item 1. BUSINESSThe Company We have developed the first and only commercially available intelligent robotic radiosurgery system, the CyberKnife system, designed to treat solidtumors anywhere in the body as an alternative to traditional surgery. For over 30 years, traditional radiosurgery systems, or systems that deliver precise,high dose radiation directly to a tumor, have been used primarily to destroy brain tumors. Our CyberKnife system represents the next generation ofradiosurgery systems, combining continuous image-guidance technology with a compact linear accelerator, or linac, that has the ability to move in threedimensions according to a patient's treatment plan. Our image-guidance technology continuously acquires images to track a tumor's location andtransmits any position corrections to the robotic arm prior to delivery of each dose of radiation. Our linac is a compact radiation treatment device thatuses microwaves to accelerate electrons to create high-energy X-ray beams to destroy the tumor. This combination, which we refer to as intelligentrobotics, extends the benefits of radiosurgery to the treatment of tumors anywhere in the body. The CyberKnife system autonomously tracks, detectsand corrects for tumor and patient movement in real-time during the procedure, enabling delivery of precise, high dose radiation typically with sub-millimeter accuracy. Traditional radiosurgery systems have limited mobility and generally require the use of a rigid frame attached to a patient's skull toprovide a coordinate system to effectively target a tumor, which restricts the ability to effectively treat tumors outside of the brain. The CyberKnifesystem does not have these limitations and therefore has increased flexibility to treat tumors throughout the body from many different directions, whileminimizing the delivery of radiation to healthy tissue and vital organs. The CyberKnife procedure requires no anesthesia, can be performed on anoutpatient basis and allows for the treatment of patients who otherwise would not have been treated with radiation or who may not have been goodcandidates for surgery. In addition, the CyberKnife procedure avoids many of the potential risks and complications that are associated with othertreatment options and is more cost effective than traditional surgery. The CyberKnife system received U.S. Food and Drug Administration, or FDA, 510(k) clearance in July 1999 to provide treatment planning andimage-guided robotic radiosurgery for tumors in the head and neck. In August 2001, the CyberKnife system received 510(k) clearance to treat tumorsanywhere in the body where radiation treatment is indicated. The CyberKnife system has also received a CE mark for sale in Europe and has beenapproved for various indications in Japan, Korea, Taiwan, China and other countries. In Europe, Japan, Korea, Taiwan, and China, the CyberKnifesystem has received1approval to provide treatment planning and image-guided robotic radiosurgery for tumors anywhere in the body where radiation treatment is indicated.We received approval for full-body treatment in Japan in June 2008; previously our CyberKnife regulatory approvals in Japan were limited to treatmentfor indications in the head and neck. As of June 30, 2008, 140 CyberKnife systems were installed. 90 in the Americas, 3 of which are pursuant to ourshared ownership program, 38 in Asia and 12 in Europe. Our customers have reported that over 50,000 patients worldwide have been treated with theCyberKnife system since its commercial introduction. Our customers have increasingly used the CyberKnife system for indications outside of the brainfor tumors on or near the spine and in the lung, liver, prostate and pancreas. Based on customer data, approximately 56% of patients treated with theCyberKnife system in the United States during the year ended June 30, 2008 were treated for tumors outside of the brain. We were incorporated in California in 1990 and commenced operations in 1992. We reincorporated in Delaware in 2007. Our principal offices arelocated at 1310 Chesapeake Terrace, Sunnyvale, CA 94089, and our telephone number is (408) 716-4600.Cancer Market Overview According to the World Health Organization, or WHO, an estimated 7.9 million people died of cancer in 2007, accounting for 13% of all deathsworldwide. Cancer is the second leading cause of death in the United States, after heart disease. The American Cancer Society, or ACS, estimates thatapproximately 560,000 Americans will die as a result of cancer in 2008. The ACS also estimates that approximately 1.4 million new cases of cancer willbe diagnosed in the United States in 2008, with continued increases in the prevalence of cancer forecasted as the U.S. population ages. Cancers can be divided broadly into two groups: solid tumor cancers, which are characterized by the growth of malignant tumors within the bodyin areas such as the brain, lung, liver, breast or prostate, and hematological, or blood-borne, cancers, such as leukemia. The ACS estimates that solidtumor cancers will account for approximately 1.36 million, or approximately 95%, of new cancer cases diagnosed and will account for approximately500,000 cancer-related deaths in the United States in 2008. In addition, tumors at the original cancer site, called primary tumors, such as in the breast orprostate, even when diagnosed and treated, can lead to the development of tumors in other locations of the body, called secondary tumors. This isreferred to as metastatic disease, the movement of cancer cells from one part of the body to another.Traditional Treatments Traditional methods for the treatment of solid tumor cancers include surgery, radiation therapy, chemotherapy and other drugs. Surgery andradiation are forms of local control, because the tumor is either directly removed through surgery or irradiated with the objective of destroying the cancercells comprising the tumor. Chemotherapy is a systemic treatment method which involves the administration of drugs with the objective of killing cancercells anywhere in the body, including any remaining cancer cells that were not destroyed by local treatment.Surgical Removal of Tumors A common treatment approach, if applicable to the patient and tumor type, is the removal of the tumor through surgery, with follow-up radiationtherapy to kill any remaining cancer cells in the area surrounding the tumor. Surgery is especially appropriate for certain types of cancer, such as breastcancer, where tumors are often well-defined and surgically accessible. However, many types of solid tumors, including those affecting the brain, thespine, the lungs and various other organs, present significant challenges to a traditional surgical approach. In many instances, these tumors occur in hardto reach areas or lie within or in close proximity to critical organs. Accordingly, it may be difficult or impossible to surgically access or remove theentire tumor or organ affected. For example, many2tumors located near the base of the skull are difficult to treat with traditional surgery without substantial risk of injury to the visual pathways or othercritical brain regions. Traditional surgery is highly invasive because it requires entering the body by incision, is painful and involves significant operative and post-operative risks, including risks associated with anesthesia, infection and other complications. For example, surgery is very difficult to perform on lungtumors because incisions in the sternum are often required to access the lung and because the lung is in motion due to respiration. Lung surgery alsoentails significant risks of post-surgical complications, including severe bleeding and pneumonia. Traditional surgery also entails significant costs andrecovery times, particularly for more complex and difficult surgeries. In addition, for elderly or seriously ill patients, surgery is not typically analternative, even if the tumor were otherwise operable. Over the past several years, minimally invasive surgical techniques have been developed to destroy tumors including cryotherapy, which is thefreezing of cancer cells, radiofrequency ablation, a process which heats and destroys tumors, and injection of ethanol directly into tumors; however,these techniques have significant limitations. Cancer cells may not be fully ablated or destroyed and the energy source used in the procedure maydamage adjoining healthy tissue or organs. In addition, these techniques are currently only available for a limited range of cancer indications. As a result,these techniques remain in limited use.Radiation Therapy Radiation therapy has been used for several decades to treat the area around a tumor site, typically as an adjunct to surgery after the tumor has beenremoved, in an attempt to eliminate remaining cancer cells in that area. Radiation therapy is also used to directly target the tumor in certain instanceswhen surgery is not possible. The goal of radiation therapy is to eliminate all cancer cells in an intended treatment region. However, healthy tissueoutside of the intended treatment region also receives substantial radiation. In order to minimize the damage to healthy tissue surrounding the tumor area,a large number of fractions, or staged treatments, are administered daily over multiple weeks. Despite staging treatments over a period of time, orfractionation, radiation therapy can still damage healthy tissue in the treated region, particularly since treatment delivery is relatively imprecise. Besidesthe potential damage to healthy tissue, radiation therapy may have a number of other adverse side effects including nausea and skin reactions. The natureand severity of these side effects can vary significantly depending on the area of the body treated and on the patient. Recent advances in radiation therapy have focused on improving the shaping and targeting of the radiation beams to minimize irradiation of healthytissue. These advances include the development of Intensity Modulated Radiation Therapy, or IMRT, which is designed to vary the intensity and shapeof the radiation beam delivered to the tumor, and Image-Guided Radiation Therapy, or IGRT, which is designed to improve targeting accuracy.However, the majority of these treatments are delivered using gantry-based linear accelerator systems that rotate the radiation source on a single axis andtherefore have a limited range of motion, which restricts treatment delivery options and generally requires manual repositioning of the patient duringtreatment. In addition, IMRT and IGRT have a limited ability to accurately target tumors, to conform to the tumor shape, and to detect and compensatefor tumor and patient motion during treatment. This results in having a cumulative radiation dose pattern for IMRT and IGRT treatments whichgenerally includes not only the tumor, but also surrounding healthy tissue.Development of Radiosurgery Based on the demonstrated principles of radiation as a method of destroying cancer cells, manufacturers have developed radiosurgery systems thathave initially shown to be effective in the treatment of brain tumors and there have been various attempts to develop similarly accurate systems3to perform radiosurgery elsewhere in the body. By destroying the tumor with a high dose of radiation, radiosurgery systems have been shown to beeffective at local control without the risks, costs and other limitations of traditional surgery. Radiosurgery systems differ from traditional radiationtherapy systems in that they are designed to deliver a very high cumulative dose of radiation, in a single or small number of treatments specificallytargeted at the tumor rather than at a region surrounding the tumor area. The delivery of more accurate radiation allows higher doses to be delivered,increasing the probability of tumor cell death and better local control. In addition, radiosurgery can be used on patients who cannot, due to advanced ageor other health reasons, tolerate traditional surgery. One of the initial radiosurgery techniques was frame-based radiosurgery for the treatment of brain tumors, which requires attaching a rigid frame tothe patient's head by screwing it into the skull through the skin to immobilize the patient's head and to aid in targeting the tumor. Besides immobilizingthe patient, the frame forms a fixed coordinate system that is used to target a tumor inside the head. Once the frame is attached, the physician thenimages the head, typically with a computed tomography, or CT, scan, to identify the tumor location relative to the frame. The physician then uses theacquired images to develop a treatment plan, and the patient receives treatment. The entire process usually lasts between four and eight hours. Although frame-based radiosurgery represents an advancement in cancer treatment, it has significant shortcomings. The necessity for a rigid frameto be screwed into a patient's skull or affixed to the body restricts the area of the body which can be treated. In addition, frame-based radiosurgerysystems do not generally succeed in conforming the radiation dose to the tumor, because beam orientations are limited, and therefore it is difficult tomatch the shape of the treated volume with the shape of the tumors. Further, because it is difficult to precisely reposition the head frame for multipletreatments, these systems are very rarely used when more than one dose of radiation is required. Frame-based radiosurgery approaches have been usedfor treatment of tumors in other parts of the body, but suffer from significant drawbacks. In particular, it is not practical to attach a frame rigidly to partsof the body other than the head. Tumors in soft tissue organs such as the lung, liver, pancreas and prostate are not rigidly fixed to any external referencepoints and can move significantly during treatment due to normal bodily functions. Frame-based approaches to delivering radiosurgery for tumors insuch locations are rarely as accurate as frame-based systems used to treat brain tumors. This lack of accuracy for tumors located outside the head maycompromise the efficacy of traditional radiosurgery and increase the likelihood of delivering significant radiation doses to otherwise healthy tissue.The CyberKnife System Solution We have developed and commercialized the CyberKnife system, an intelligent robotic radiosurgery system designed to treat solid tumorsthroughout the body where radiation is indicated as an alternative to traditional surgery. The CyberKnife system combines continuous image-guidancetechnology with a compact linear accelerator mounted on a computer-controlled manipulator arm to precisely deliver high doses of radiation to a tumorfrom many different directions. Our system tracks, detects and corrects for tumor and patient movement in real-time during treatment and preciselydelivers high doses of radiation to a tumor typically with sub-millimeter accuracy. Key benefits of the CyberKnife system include: Treatment of inoperable or surgically complex tumors. The CyberKnife system can be used to target tumors that cannot be easily treated withtraditional surgical techniques because of their location, number, size, shape or proximity to vital tissues or organs, or because of the age or health of thepatient. The CyberKnife system's intelligent robotics are designed to enable the delivery of radiation doses that conform closely to the shape of thetumor. This enables the precise targeting of a tumor, while at the same time minimizing damage to surrounding healthy tissue. Treatments performedwith the CyberKnife system can also be staged over two to five treatment sessions.4 Treatment of tumors throughout the body. The CyberKnife system has been cleared by the FDA to provide treatment planning and image-guided radiosurgery for tumors anywhere in the body where radiation treatment is indicated. Unlike frame-based radiosurgery systems, which aregenerally limited to treating brain tumors, the CyberKnife system is being used for the treatment of primary and metastatic tumors outside the brain,including tumors on or near the spine and in the lung, liver, prostate and pancreas. Real-time tracking of tumor movement. We believe the CyberKnife system is the first device that is designed to enable the treatment of tumorsthat may change position due to tumor and patient movement during treatment. That ability is achieved with a level of accuracy typically associated withradiosurgery procedures for brain tumors. In addition, our Synchrony motion tracking system enables highly accurate treatment of tumors that movewith respiration. Significant patient benefits. Patients may be treated with the CyberKnife system on an outpatient basis without anesthesia and without the risksand complications inherent in traditional surgery. The CyberKnife procedure is well tolerated. Patients do not require substantial pre-treatmentpreparation, and typically there is little to no recovery time or hospital stay associated with the CyberKnife procedure. In addition, the CyberKnifesystem eliminates the need for an invasive rigid frame to be screwed into the patient's skull or affixed to other parts of the body. Facilitates additional revenue generation through increased patient volumes. We believe that the CyberKnife system allows our customers toeffectively treat patients that otherwise would not have been treated with radiation or who may not have been good candidates for surgery. Therefore,we believe the treatment of these patients generates additional revenue without affecting our customers' traditional radiation therapy practices. Inaddition, because the CyberKnife treatment is a non-invasive, outpatient procedure requiring little or no recovery time, hospitals can treat more patientsthan through traditional surgery. In traditional surgery, the time a patient must be at the facility for the procedure and the recovery time tend to bemeasured in days. With the CyberKnife system, the entire procedure is generally completed within 90 minutes, and the patient often leaves the facilityvery shortly after treatment. Even if the patient receives four to five treatments, the total time the patient is at the hospital or treatment center is stillshorter than with traditional surgery. Furthermore, the more time the patient must be at the hospital, the more resources the hospital must dedicate to thepatient. The reduction in overall time and resources required for the CyberKnife procedure, when compared to traditional surgery, leads to an increase inthe volume of procedures performed and lower per procedure costs for the hospital. The combination of incremental revenue generation and lower perprocedure cost makes the CyberKnife system an attractive addition to our customers' cancer treatment practice. Upgradeable modular design. Our CyberKnife system has a modular design which facilitates the implementation of upgrades without requiringour customers to purchase an entirely new system. We have a well-established track record of developing and delivering state-of-the-art upgrades to ourcustomers, enabling our customers to take advantage of the continued evolution of our CyberKnife system. We continue to develop and offer newclinical capabilities enhancing ease of use, reducing treatment times, improving accuracy and improving patient access.Our Strategy Our goal is to have the CyberKnife system become the standard of care for the treatment of solid tumors, particularly those that are difficult to treatwith traditional surgery. We believe our technology5can significantly enhance the applications of radiosurgery by increasing the number and type of tumors which can be treated effectively. Key elements ofour strategy include the following: Increase physician adoption and patient awareness to drive utilization. We are continually working to increase adoption and awareness of ourCyberKnife system and demonstrate its advantages over traditional treatment methods. We intend to increase the number of worldwide sales andmarketing personnel in order to increase sales and drive utilization of the CyberKnife system. In addition, we will continue to hold and sponsorsymposia and educational meetings and to support clinical studies in an effort to demonstrate the clinical benefits of the CyberKnife system. Finally, wewill continue to assist our customers in increasing patient awareness in their communities by helping them develop marketing and educationalcampaigns. Continue to expand the radiosurgery market. While radiosurgery has traditionally been used to treat brain tumors, the CyberKnife system hasreceived FDA clearance for and is increasingly being used to treat tumors anywhere in the body where radiation is indicated. Based on customer data,approximately 56% of patients treated with the CyberKnife system in the United States during the year ended June 30, 2008 were treated for tumorsoutside of the brain. We are facilitating studies to further demonstrate the CyberKnife system's efficacy for treating tumors outside of the brain, and webelieve these studies will increase overall utilization of the CyberKnife system and continue to expand the number of patients eligible for radiosurgery.In addition, we have developed and are continuing to develop new upgrades to enable the CyberKnife system to be even better suited for treating tumorsanywhere in the body where radiation is indicated. Continue to innovate through clinical development and collaboration. The clinical success of the CyberKnife system is due in large part to thecollaborative partnerships we have developed over the last decade with clinicians, researchers and patients. We proactively seek out and rely onconstructive feedback from CyberKnife system users to learn what is needed to enhance the technology. Due to this collaborative process, wecontinually refine and upgrade the CyberKnife system, which ultimately improves our competitive position in the radiosurgery market. Our upgrades aredesigned to improve the ease of use and accuracy of treatment, decrease the treatment times, and improve the utilization for specific types of tumors. Forexample, in recent years, we introduced Synchrony, a motion tracking system that is designed to track tumors that move with patient respiration and theXsight Spine Tracking System, a new target tracking technology, which eliminates the need for surgical implantation of small, inert metal markers,known as fiducials, in the treatment of spinal tumors. In the year ended June 30, 2007, we introduced the Patient Archive and Restore System, theRoboCouch patient positioning system, the Xsight Lung Tracking System, the Xchange robotic collimator changer and the 4D Treatment Optimizationand Planning System. In the year ended June 30, 2008, we introduced a higher output linear accelerator, the IRIS Variable Aperture Collimator,MonteCarlo Dose Calculation software, Sequential Optimization treatment planning and a seated RoboCouch, enabling improved patient positioningcapabilities. We also maintain close relationships with our customers through our shared ownership program and service plans. This further enables usto understand their needs and allows us to develop new technologies and upgrades that improve and expand clinical applications and drive increasedutilization of our CyberKnife system. Leverage our installed base to generate additional recurring revenue. We have designed the CyberKnife system so that customers mayupgrade their previously purchased systems as we introduce new features. We generate additional revenue by selling multiyear service plans thatprovide eligibility to receive upgrades, when and if available. These contracts are typically signed at the time of CyberKnife system purchase andgenerate additional revenue throughout the life of the contract. In addition, we sell upgrades to our existing customers who are not covered by serviceplans or who have exhausted the upgrades deliverable pursuant to their service plans. Finally, we offer the shared ownership program, which enablescustomers to reduce the upfront investment required for the CyberKnife system in exchange for sharing a significant portion of revenue with us that isderived from each procedure.6 Continue to expand international sales and geographic reach. We intend to increase our sales and distribution capabilities outside of theUnited States to take advantage of the large international opportunity for our products. We currently have regional offices in Paris, France, Hong Kong,China, Tokyo, Japan, Madrid, Spain, New Delhi, India, and Singapore and our sales and distribution channels cover more than 50 countries. We intendto increase our international revenue by increasing the number of distributors and direct sales and support personnel in targeted new internationalmarkets, and by further penetrating our established international markets. In an effort to streamline our sales efforts in Japan, our former distributor Meditec Corporation transferred all of its inventory of our products toour existing distributor Chiyoda Technol Corporation in the year ended June 30, 2006. As part of that inventory transfer, Meditec paid us a lump sumpayment for such inventory. Meditec is a subsidiary of Marubeni Corporation, one of our former stockholders. Marubeni Corporation transferred itsinterest in the Company during September 2007 and is no longer a stockholder of record of the Company as of June 30, 2008. Pursue acquisitions, strategic partnerships and joint ventures. We intend to actively pursue acquisitions, strategic partnerships and jointventures that we believe may allow us to complement our growth strategy, increase market share in our current markets and expand into adjacentmarkets, broaden our technology and intellectual property and strengthen our relationships with our customers.The CyberKnife System Our principal product is the CyberKnife system, an intelligent robotic radiosurgery system that enables the treatment of tumors anywhere in thebody where radiation is indicated without the need for invasive surgery or rigid frames. The current United States list price for the CyberKnife systemranges from approximately $4.2 million to $5.75 million depending upon system configuration and options purchased by the customer. The list pricetypically includes initial training, installation and a one-year warranty. We also offer optional hardware and software, technical enhancements andupgrades to the CyberKnife system, as well as service contracts and training to assist customers in realizing the full benefits of the CyberKnife system.As of June 30, 2008, we had 140 units installed at customer sites: 90 in the Americas, 3 of which are pursuant to our shared ownership program, 38 inAsia and 12 in Europe. The CyberKnife system combines continuous image-guidance technology with a compact linear accelerator mounted on a computer-controlledmanipulator arm to precisely deliver high doses of radiation to the tumor from numerous directions during treatment. Our patented image-guidancetechnology correlates low dose, real-time treatment X-rays with images previously taken with a CT scan of the tumor and surrounding tissue toprecisely direct each beam of radiation. This enables delivery of a highly conformal, non-isocentric dose of radiation to the tumor, with minimalradiation delivered to surrounding healthy tissue. With its autonomous ability to track, detect and correct for even the slightest tumor and patientmovement throughout the entire treatment, the CyberKnife system gives clinicians an effective, uninterrupted and accurate treatment alternative. Key components and technologies of the CyberKnife system include the following: Compact X-band linear accelerator. This compact linac generates the radiation that destroys the tumor. We believe we are the only commercialmanufacturer of a compact X-band linac. This technology allows us to manufacture linacs that are smaller and weigh significantly less than standardmedical linacs used in radiation therapy while achieving similar performance. Our linac can provide high energy X-ray beams of different diameters andintensities without the use of radioactive material. In fiscal 2008, we introduced a linac capable of delivering 800 monitor units per minute of energyoutput, representing the highest output linac we have offered. Robotic manipulator. The manipulator arm, with six-degrees-of-freedom range of movement, is designed to move and direct the linac with anextremely high level of precision and repeatability. The7manipulator arm allows doses of radiation to be delivered from nearly any direction and position, without the limitations of gantry-based systems,creating a non-isocentric composite dose pattern that can precisely conform to the shape of each treated tumor. This flexibility enhances the ability todiversify beam trajectories and beam entrance and exit points, helping to minimize risks of radiation damage to healthy cells near the tumor.Furthermore, the rapid response time of the manipulator arm allows tracking of tumors that move with respiration in real time. Real-time image-guidance system with continuous target tracking and feedback. Without the need for clinician intervention or treatmentinterruption, the CyberKnife system's revolutionary real-time image-guided robotics enables the CyberKnife system to continuously monitor and correctfor patient and tumor movements throughout treatment. The CyberKnife system is able to provide the precise delivery of radiation because of thevirtually instantaneous and continuous feedback loop between X-ray-based target localization and automatic correction of the radiation beam throughoutthe entire treatment. This target tracking and feedback technology uses two digital image detectors to capture low energy X-ray images. The imageguidance software carries out an automated comparison of the X-ray images with the patient's CT scan to detect, track and correct for any movement ofthe tumor or patient before and during the treatment delivery. This allows the CyberKnife system to dynamically target the tumor and adjust the positionof the beam to follow the motion of the tumor throughout the treatment, directing the beam to precisely match tumor movement. X-ray sources. The low-energy X-ray sources generate X-ray images to determine the location of bony landmarks or implanted fiducialsthroughout the entire treatment. Image detectors. The image detectors capture high-resolution anatomical images throughout the treatment. These live images are continuallycompared to previously captured digitally reconstructed radiographs to determine real-time patient positioning. Based on this information, the roboticmanipulator instantly corrects for any detected movement. In addition to the key components listed above, we also offer the following components and features, several of which have been introduced asupgrades since 2004, including: Synchrony respiratory tracking system. The CyberKnife system employs a proprietary motion tracking system called Synchrony, for targetingtumors that move during respiration. Synchrony software and hardware correlate tumor movement due to respiration with the CyberKnife systemtreatment beam allowing it to continuously track the tumor as it moves throughout the respiratory cycle. Through this process the CyberKnife systemdelivers beams synchronized in real-time to tumor position while adapting to changes in breathing patterns, allowing for the delivery of highlyconformed radiation beams while reducing areas exposed to radiation and unprecedented clinical accuracy of approximately 1.5 millimeters. Xsight Spine Tracking System. For most extracranial tumors, the CyberKnife system uses implanted fiducials to track the position of the tumorthroughout treatment. However, the Xsight Spine Tracking System eliminates the need for surgical implantation of fiducials in the delivery ofradiosurgery treatments on or near the spine. The Xsight Spine Tracking System utilizes skeletal structures to automatically locate and track tumors withsub-millimeter accuracy. We believe no other commercially available technology today offers this capability. RoboCouch patient positioning system. Fully integrated with the CyberKnife system, the RoboCouch intelligently positions the patient to theplanned treatment position with unprecedented accuracy, providing not only greater set up precision, but significantly streamlining the patient set upprocess. The versatility of the RoboCouch allows for automated patient positioning prior to treatment. Additionally, the RoboCouch offers greaterpositioning flexibility, a lower patient loading height, and a higher patient weight capacity limit when compared to our standard treatment couch.8 Xsight Lung Tracking System. The Xsight Lung Tracking System delivers radiosurgical accuracy to some lung tumors without the need forimplanted fiducials. The Xsight Lung Tracking System directly tracks the anatomy of the tumor. Integrated with the Synchrony Respiratory TrackingSystem, treatment margins are significantly minimized by tracking the motion of the tumor as it moves in respiration. Xchange robotic collimator changer. The Xchange robotic collimator changer automatically exchanges secondary collimators, which determinethe radiation beam size, during the treatment. The use of multiple collimators can enable faster treatments than the use of a single collimator. IRIS variable aperture collimator. The IRIS variable aperture collimator enables delivery of beams in 12 unique sizes with a single collimator.This can significantly reduce treatment times as well as the total radiation dose delivered to the patient. IRIS is offered in conjunction with the Xchangerobotic collimator changer. In-Room CT System. The In-Room CT System enables diagnostic quality 3D and 4D patient imaging just prior to treatment. Combined with theRoboCouch patient positioning system, the In-Room CT System provides a smooth and efficient scan-to-treatment transition without having to re-enterthe treatment room or manually move the patient. The In-Room CT System is manufactured by Siemens Medical and resold by us pursuant to ouragreement with Siemens Medical USA, Inc. 4D Treatment Optimization and Planning System. Our 4D Treatment Optimization and Planning System optimizes treatment by taking intoaccount the movement of the tumor as well as the movement and deformation, or change in shape, of the surrounding tissue, thereby minimizingmargins and radiation exposure to healthy tissue. MultiPlan treatment planning system. Our proprietary intuitive planning system called MultiPlan is designed for radiosurgery and includes astandard computer workstation. MultiPlan calculates a treatment plan that produces a pattern of radiation designed to conform to the tumor. TheMultiPlan system uses input images from multiple modalities, including computed tomography, or CT, magnetic resonance imaging, or MRI, positronemission tomography, or PET, and 3D angiography. After the physician outlines a tumor and critical adjacent tissues on the computer, a radiationscientist uses the MultiPlan system to plan the number, intensity, position and direction of radiation beams. Using unique and patented softwarealgorithms, the system calculates and displays the resultant treatment plan for evaluation, optimization and approval by the physician. Monte Carlo dose calculation. Our Monte Carlo dose calculation software uses Monte Carlo simulation algorithms in treatment planning anddose calculation. Our Monte Carlo dose calculation algorithm can perform the necessary treatment planning calculations in a significantly shorter timeframe as compared to conventional Monte Carlo dose calculation methods, thereby accelerating the treatment planning process. Sequential Optimization treatment planning. Sequential optimization treatment planning enables CyberKnife System users to define andprioritize treatment planning objectives for each treatment plan. These objectives can include treatment dose to the targeted tumor, dose minimization insurrounding areas and total radiation delivery throughout the treatment. Sequential optimization enables these objectives to be prioritized and tailored tothe unique clinical characteristics of each patient. Patient Archive and Restore System. The Patient Archive and Restore System increases utilization by moving the archive and restore processesfrom the treatment delivery workstation to an independent archiving system. InView remote review system. The CyberKnife system employs a remote review workstation to allow referring physicians to participate in thetreatment process, called InView. InView allows physicians to combine and contour diagnostic images as well as review potential treatment plans asgenerated by MultiPlan prior to the CyberKnife procedure. By placing InView in physician offices or9clinics, we believe that we can expand the number of patients referred for treatment using the CyberKnife system. Standard treatment couch. Our standard treatment couch is a computer-controlled treatment couch that is integrated with the image-guidancesystem. The treatment couch automatically aligns the patient for treatment at the beginning of the procedure. The treatment couch also positions thepatient so that the tumor is in the center of the imaging field. When the tumor is correctly positioned, treatment begins and the CyberKnife systemtracking software guides the radiation beams to the precise tumor location.CyberKnife System Clinical Workflow The CyberKnife procedure involves scanning, planning, treatment and follow-up, and may be performed on an outpatient basis. Scanning. Prior to treatment with the CyberKnife system, the patient undergoes imaging procedures to determine the size, shape and location ofthe tumor. The process begins with a standard high-resolution CT scan. Preparation for the scan may also include the placement of fiducials, in oraround the tumor when treating tumors outside the brain. For certain tumors, such as brain and spinal tumors, where greater differentiation betweendifferent types of soft tissue is required, other imaging techniques, such as MRI, angiography, or PET, may also be used to more accurately differentiatethe tumor from surrounding healthy tissue. Our software helps integrate CT scans and other imaging data into the pre-treatment planning process. Planning. Following the scanning, the image data is then digitally transferred to the CyberKnife system's treatment planning workstation, wherethe treating physician identifies the exact size, shape and location of the tumor to be targeted and the surrounding vital structures to be avoided. Aqualified physician and/or radiation scientist or physicist then uses our proprietary software to generate a treatment plan to provide the desired radiationdose to the identified tumor location without exceeding the tolerance of adjacent healthy tissue. As part of the treatment plan, our proprietary planningsoftware automatically determines the number, duration and angles of delivery of the radiation beams. Treatment. During a CyberKnife procedure, a patient lies on the treatment table, which automatically positions the patient. Anesthesia is notrequired, as the procedure is painless and non-invasive. The treatment, which generally lasts between 30 and 90 minutes, typically involves theadministration of between 100 and 200 radiation beams delivered from different directions, each lasting from 10 to 15 seconds. Prior to the delivery ofeach beam of radiation, the CyberKnife system has the ability to simultaneously take a pair of X-ray images and compare them to the original CT scan.This image guided approach continuously tracks, detects and corrects for any movement of the patient and tumor throughout the treatment to ensureprecise targeting. The patient usually leaves the facility immediately upon completion of the procedure. Follow-up. Follow-up imaging, generally with either CT or MRI, is usually performed in the weeks and months following the treatment toconfirm the destruction and eventual elimination of the treated tumor.Shared Ownership Program and Other Services We provide a variety of services to support the operation and use of our CyberKnife systems. We expect that these services will enable us togenerate a recurring revenue stream that will continue to make up an important portion of our revenue.10CyberKnife System Shared Ownership Program We offer the shared ownership program under which we provide a CyberKnife system to a customer while retaining ownership of that system. Inaddition, we provide physician training, educational support, general reimbursement guidance and technical support, as well as possible future upgradesto customers under this program. In return, these customers are generally required to pay us the greater of a minimum payment or a portion of therevenue generated through the use of the CyberKnife system. Generally, this minimum monthly payment is equivalent to the revenue generated fromtreating three to four patients per month, and any revenue received from additional patients is shared between us and the customer. Customers whoparticipate in our shared ownership program are responsible for costs associated with facility preparation and professional and administrative personnelrequired to operate the CyberKnife system. Our legacy shared ownership program was known as our placement program. Agreements under the shared ownership program typically have a term of five years, during which the customer has the option to purchase thesystem, either at the end of the contractual period or earlier, at the customer's request, at pre-determined prices. Through June 30, 2008, we had installed17 systems under our shared ownership program, 14 of which had subsequently been sold by that date. During the years ended June 30, 2008 and2007, $23.7 million and $3.0 million, respectively, of total revenue was recognized in the consolidated statements of operations for the sale of 12 and 1CyberKnife system units, respectively, that were formerly under the shared ownership program. At June 30, 2008 and 2007, $2.3 million and $50,000,respectively, of amounts for extended warranty and training services related to these sold shared ownership units remained recorded as deferredrevenue, and will be recognized over the life of the extended warranty service period and as training service obligations are fulfilled. As of June 30,2008, three shared ownership units remained active in our installed base.Warranty and Support Services We generally provide a one-year warranty on the purchase of the CyberKnife system. The warranty period commences on completion of systeminstallation. In addition, for a fee that is fixed at the time of purchase, customers can enroll in one of our multiyear service plans: Diamond Elite multiyear service plan. Under our Diamond Elite multiyear service plan, or Diamond plan, our customers have the opportunityto acquire up to two unspecified future upgrades per year, when and if they become available. If we offer more than two upgrades a year, customers canexchange their right to receive future upgrades for the current upgrades available. Through June 30, 2008, the Diamond plan listed for $460,000 peryear and provided for annual renewals for four years. Effective July 1, 2008, the Diamond plan lists for $495,000 per year and provides for annualrenewals for five years. Basic and Emerald multiyear service plans. We also offer a basic multiyear service plan, and our Emerald multiyear service plan, or Emeraldplan, following the initial one-year warranty period. Under our Emerald plan, customers receive a higher level of support, including a faster responsetime and coverage for all replacement parts than under our basic service plan. Through June 30, 2008, the list prices of our basic and Emerald serviceplans were $220,000 and $275,000, respectively. As of July 1, 2008, the list prices of our basic and Emerald service plans are $200,000 and $325,000,respectively. Legacy multiyear service plans. Prior to introducing our Diamond plan, we offered a Platinum Elite multiyear service plan, or Platinum plan, tocustomers in the United States and our Gold Elite multiyear service plan, or Gold plan, to customers outside the United States. While these plans are nolonger offered, as of June 30, 2008 we were still servicing approximately 44 customers pursuant to these legacy multiyear service plans. Thesemultiyear service plans typically provide for annual renewals for11four years, including the one-year warranty period. Beginning in November 2005, we phased out offering these legacy service plans to new customers. Under our Platinum plan, in addition to technical support, customers have the opportunity to acquire at least two future upgrades per year for amaximum of eight upgrades over the three or four year term of the arrangement, for an annual fee of approximately $425,000. If we do not offer at leasttwo upgrades per year, the customer would be entitled to a refund of up to $100,000 for each upgrade not offered. We have not yet established objectiveevidence of fair value of those future obligations; hence, generally accepted accounting principles in the United States, or GAAP, requires that wecannot begin to recognize any of the revenue derived from the sale of a CyberKnife system or the associated service plan until those specifiedobligations have been fulfilled. Therefore, the payments made by our customers who have our legacy Platinum plan are categorized as deferred revenueand will be recognized as revenue when we fulfill all obligations to deliver upgrades. Once we fulfill all upgrade obligations with respect to a specificPlatinum plan, we will ratably recognize the revenue from the sale of the CyberKnife system and the Platinum plan over the remaining life of thecontract. Under our Gold plan, customers typically have the opportunity to acquire up to two unspecified future software upgrades per year, for an annualfee of $350,000. If we do not offer an upgrade in any particular year, the customer would be entitled to a refund of up to $100,000 for each upgrade notoffered, except in Japan. Pursuant to the Gold plan customers are required to pay for additional hardware if required for the implementation of newsoftware features. To date no refunds have been required pursuant to these multiyear service plans. Installation and service. We perform the installation and service of the CyberKnife system in the United States and in selected countries outsidethe United States. In addition, we have trained third-party service organizations and trained our distributors in Korea, Taiwan, Turkey, India, China andItaly to perform the CyberKnife system installation and service. We employ service engineers and technical staff with a high degree of expertise, whichis required due to the complexity of the CyberKnife system. Training. In addition to the training we offer with the initial installation of the CyberKnife system and the training required when an upgrade isinstalled, we offer various training sessions for our customers or our distributors for an additional fee.Sales and Marketing We currently market the CyberKnife system through a direct sales force in the United States and a combination of direct sales personnel anddistributors in the rest of the world. Support of our international sales is handled through our European and Asian headquarters in Paris, France and inHong Kong, China. In the United States we use a combination of regional sales directors, sales specialists, customer account sales executives, product managers,account managers and training specialists. Regional sales directors and sales specialists are responsible for selling the CyberKnife system to hospitalsand stand-alone treatment facilities. Our customer account sales executives sell upgrade products to existing customers. Our product managers helpmarket our current products and work with our engineering group to identify and develop upgrades and enhancements for the CyberKnife system. Ouraccount managers are primarily responsible for supporting the CyberKnife systems with marketing and education after installation is completed. Ourtraining specialists train radiation oncologists, surgeons, physicists and radiation therapists. In addition, during fiscal 2008, we established a corporate accounts group within the sales organization. This group has responsibility for targetingmajor national and strategic accounts including hospital groups, operators of multiple radiation oncology centers and group purchasing organizations.We believe that organizations of this nature represent an opportunity for CyberKnife system sales and that they require a different sales focus due totheir national or multi-regional scope.12 In addition to marketing to hospitals and stand-alone treatment facilities, we market to radiation oncologists, neurosurgeons, general surgeons,oncology specialists and other referring physicians. We will continue to increase our focus on marketing and education efforts to surgical specialists andoncologists responsible for treating tumors throughout the body. Our marketing activities also include efforts to inform and educate cancer patientsabout the benefits of the CyberKnife system. According to estimates published by the American Society for Therapeutic Radiology and Oncology, or ASTRO, there are over 2,000 hospitalsand stand-alone treatment facilities in the United States providing radiation therapy services. Our current United States sales and marketing focus is totarget the hospitals and treatment facilities currently providing radiation therapy services, however, in the future we believe that the CyberKnife systemwill also be marketed to hospitals that do not have radiation therapy facilities. In April 2007, we entered into a Distribution and Remarketing Agreement with Siemens Medical Solutions Inc. USA, acting through its OncologyCare Systems Group, or OCS, pursuant to which we are authorized to purchase, license, sell, and sublicense certain OCS products directly from OCS.OCS granted us the right to purchase and license certain models of CT scanners from OCS, and to promote, market, lease, resell and sublicense the CTscanners to end users, either directly or through its channels of distribution, in the United States and other territories, and to market the CT scanners inconjunction with our CyberKnife and/or RoboCouch products. From time to time, we may provide our linac system for use in non-medical areas. These areas may include non-destructive testing, visualinspection and other potential applications.Manufacturing and Assembly We purchase major components of the CyberKnife system, including the robotic manipulator, treatment table or robotic couch, magnetron, whichcreates the microwaves for use in the linac, imaging cameras and computers, from outside suppliers. We manufacture certain other electronic andelectrical subsystems, including the linac, at our Sunnyvale, California and Mountain View, California facilities. We then assemble and integrate thesecomponents with our proprietary software for treatment planning and treatment delivery and perform essential testing prior to shipment to customersites. Single source suppliers presently provide us with several components, including the magnetron, the treatment couches and the imaging plates. Inmost cases, if a supplier were unable to deliver these components, we believe that we would be able to find other sources for these components subjectto any regulatory qualifications, if required. In the event of a disruption in any of these suppliers' ability to deliver a component, we would need tosecure a replacement supplier. Additionally, any disruption or interruption of the supply of key subsystems could result in increased costs and delays indeliveries of CyberKnife systems, which could adversely affect our reputation and results of operations.Intellectual Property The proprietary nature of, and protection for, our products, product components, processes and know-how are important to our business. We seekpatent protection in the United States and internationally for our product systems and other technology where available and when appropriate. Ourpolicy is to patent or in-license the technology, inventions and improvements that we consider important to the development of our business. In addition,we use license agreements to selectively convey rights to our intellectual property to others. We also rely on trade secrets, know-how and continuinginnovation to develop and maintain our competitive position. We had nine U.S. patent applications allowed in the year ended June 30, 2008. As of June 30, 2008, we held 30 U.S. patents, 72 pending U.S.patent applications and are pursuing additional patent applications on additional key inventions to enhance our intellectual property rights. The first ofour patents will expire in 2010 and currently the last of our patents will expire in 2025. As of June 30, 2008,13we also held 22 foreign patents, 10 pending published Patent Cooperation Treaty applications and 74 foreign patent applications which correspond toour issued U.S. patents and pending U.S. patent applications. We cannot be sure that any patents will issue from any of our pending patent applications,nor can we assure you that any of our existing patents or any patents that may be granted to us in the future will be commercially useful in protectingour technology. An additional key component of our intellectual property is our proprietary software used in planning and delivering the CyberKnifesystem's therapeutic radiation dose. In addition to our patents, we also rely upon trade secrets, know-how, trademarks, copyright protection and continuing technological and licensingopportunities to develop and maintain our competitive position. We require our employees, consultants and outside scientific collaborators to executeconfidentiality and invention assignment agreements upon commencing employment or consulting relationships with us. Patents may provide some degree of protection for our intellectual property. However, patent protection involves complex legal and factualdeterminations and is therefore uncertain. In addition, the laws governing patentability and the scope of patent coverage continue to evolve, particularlyin the areas of technology of interest to us. As a result, we cannot assure you that patents will issue from any of our patent applications. The scope ofany of our issued patents may not be sufficiently broad to offer meaningful protection. In addition, our issued patents or patents licensed to us may besuccessfully challenged, invalidated, circumvented or unenforceable so that our patent rights would not create an effective competitive barrier.Moreover, the laws of some foreign countries may not protect our proprietary rights to the same extent as do the laws of the United States. In view ofthese factors, our intellectual property positions bear some degree of uncertainty. We have also entered into licensing agreements with third parties relating to rights and technologies. On January 30, 1991, we entered into aManufacturing License and Technology Transfer Agreement with Schonberg Radiation Corporation under which Schonberg granted us a perpetualexclusive license to use and manufacture products utilizing some of Schonberg's patent and other intellectual property rights relating to the design,engineering and manufacturing of the compact linacs that may be used in the CyberKnife system for medical applications. On November 29, 2006, weentered into a Patent and Trademark License Agreement with Forte Automation Systems, Inc., or Forte, under which we granted Forte a license,exclusive with respect to one customer for patent rights and trademark rights related to our patient positioning system. In April 2007, we entered into a License and Development Agreement with CyberHeart, Inc., or CyberHeart. As part of this agreement, we willlicense certain intellectual property rights and technologies to CyberHeart, which CyberHeart will use to develop and commercialize new systems andapplications in the field of cardiac disease. In the event CyberHeart is able to successfully develop and commercialize such an application, under theagreement, we would be the sole supplier of radiosurgery equipment to CyberHeart and would also be entitled to receive specified payments based onusage of the CyberHeart system. Roderick Young, a former member of our board of directors, is a founder, officer and director of CyberHeart, Inc. In December 2004 and in connection with our acquisition of American Science & Engineering's, or AS&E's, High Energy Systems, or HES,business, in January 2005, we entered into a license agreement with AS&E relating to the intellectual property we obtained from the HES acquisition.We granted AS&E an exclusive, worldwide, fully paid license for use of the purchased intellectual property in the national security and non-destructivetesting markets, as well as a non-exclusive worldwide, fully paid license of the intellectual property for all uses other than (a) the national security andnon-destructive testing markets and (b) medical use or applications. In addition, we received an exclusive, worldwide, fully paid license to anymodifications, improvements, enhancements or new developments to the acquired intellectual property by AS&E which are limited to medical uses orapplications. We recently began the development of a next-generation linac, using technology developed independently from the14intellectual property we obtained from the HES acquisition. We are developing this technology for medical uses and applications and other markets,including national security and non-destructive testing. In October 2006, January 2007 and February 2007, we received correspondence from AS&Eexpressing concerns that we may be using the intellectual property obtained from the HES acquisition in a manner that breaches, or may intend tobreach, our contractual obligations under the license agreement. As of June 30, 2008, we have not received any further correspondence from AS&Eregarding this issue. The intellectual property at issue relates to the development of a next-generation linac for use in national security and non-destructive testing areas, as well as medical uses. We are developing the technology used in the next-generation linac independently from the intellectualproperty we obtained from the HES acquisition. While we do not believe our activities breach or violate the terms of the license agreement, we cannotassure you that AS&E will not assert that we are breaching our obligations under our license agreement with them. In July 1997, we entered into a license agreement with The Board of Trustees of the Leland Stanford Junior University for technology and patentsto develop, manufacture, use and sell products utilizing feature matching technology to align images used in radiosurgery. Although we are not currently a party to any legal proceedings relating to our intellectual property, in the future, third parties may file claimsasserting that our technologies or products infringe on their intellectual property. We cannot predict whether third parties will assert these claims againstus or against the licensors of technology licensed to us, or whether those claims will harm our business. If we are forced to defend against these claims,whether they are with or without any merit, whether they are resolved in favor of or against us or our licensors, we may face costly litigation anddiversion of management's attention and resources. As a result of these disputes, we may have to develop costly non-infringing technology, or enter intolicensing agreements. These agreements, if necessary, may be unavailable on terms acceptable to us, if at all, which could seriously harm our businessor financial condition.Research and Development Continued innovation is critical to our future success. Our current product development activities include projects expanding clinical applications inradiosurgery, driving product differentiation, and continually improving the CyberKnife system's capabilities. Some of our product upgrades includeSynchrony, Xsight Spine Tracking System, InView, MultiPlan, RoboCouch, IRIS, MonteCarlo dose calculation, and Sequential Optimization treatmentplanning. Research activities strive to enable new product development opportunities by developing new technologies and advancing areas of existingcore technology such as a next generation linac. The modular design of our products supports rapid development for new clinical capabilities and performance enhancements by generally allowingeach subsystem to evolve within the overall platform design. Access to regular product upgrades protects customer investment in the CyberKnifesystem, facilitates the rapid adoption of new features and capabilities among existing installed base customers, and drives increasing value in ourmultiyear service plans. These upgrades will generally consist of software and hardware enhancements designed to increase the ease of use of ourCyberKnife system and improve the speed and accuracy of treatment. As of June 30, 2008, we had 139 employees in our research and development departments. Research and development expenses for the fiscalyears ended June 30, 2008, 2007 and 2006 were $32.9 million, $26.8 million and $17.8 million, respectively. We plan to continue to increase ourinvestment in research and development in future periods.15Competition The medical device industry in general, and the non-invasive cancer treatment field in particular, are subject to intense and increasing competitionand rapidly evolving technologies. Because our products often have long development and government approval cycles, we must anticipate changes inthe marketplace and the direction of technological innovation and customer demands. To compete successfully, we will need to continue to demonstratethe advantages of our products and technologies over well-established alternative procedures, products and technologies, and convince physicians andother healthcare decision makers of the advantages of our products and technologies. Traditional surgery, minimally invasive procedures, radiationtherapy, chemotherapy and other drugs are other means to treat cancer. Also, we compete directly with frame-based radiosurgery systems primarilyfrom Elekta AB (publ), or Elekta, BrainLAB AG, and the Integra Radionics business of Integra Life Sciences Holding Corporation. The market for standard linacs is dominated by three companies: Elekta, Siemens AG, or Siemens, and Varian Medical Systems, Inc., or Varian.In addition, TomoTherapy Incorporated, or TomoTherapy, markets a radiation therapy product. The CyberKnife system does not perform radiotherapy,which uses low doses of radiation over a long period of time with fractionated treatments to kill cancer cells, and generally does not compete directlywith standard medical linacs that perform traditional radiotherapy, although some manufacturers of standard accelerator systems, including Varian andElekta, have products that can be used in combination with body and/or head frame systems and image-guidance systems to perform radiosurgery. Inaddition, many government, academic and business entities are investing substantial resources in research and development of cancer treatments,including surgical approaches, radiation treatment, drug treatment, gene therapy, which is the treatment of disease by replacing, manipulating, orsupplementing nonfunctional genes, and other approaches. Successful developments that result in new approaches for the treatment of cancer couldreduce the attractiveness of our products or render them obsolete. Our future success will depend in large part on our ability to establish and maintain a competitive position in current and future technologies. Rapidtechnological development may render the CyberKnife system and its technologies obsolete. Many of our competitors have or may have greatercorporate, financial, operational, sales and marketing resources, and more experience in research and development than we have. We cannot assure youthat our competitors will not succeed in developing or marketing technologies or products that are more effective or commercially attractive than ourproducts or that would render our technologies and products obsolete. We may not have the financial resources, technical expertise, marketing,distribution or support capabilities to compete successfully in the future. Our success will depend in large part on our ability to maintain a competitiveposition with our technologies. Our competitive position also depends on:•widespread awareness, acceptance and adoption of our products by the radiation oncology and cancer therapy markets; •the discovery of new technologies that improve the effectiveness and productivity of the CyberKnife system radiosurgery process; •availability of coverage and reimbursement from third-party payors, insurance companies and others for procedures performed using theCyberKnife system; •properly identifying customer needs and delivering new upgrades to address those needs; •published studies supporting the efficacy and safety of the CyberKnife system; •limiting the time required from proof of feasibility to routine production;16•limiting the timing and cost of regulatory approvals; •the manufacture and delivery of our products in sufficient volumes on time, and accurately predicting and controlling costs associatedwith manufacturing, installation, warranty and maintenance of the products; •our ability to attract and retain qualified personnel; •the extent of our patent protection or our ability to otherwise develop proprietary products and processes; •securing sufficient capital resources to expand both our continued research and development, and sales and marketing efforts; and •obtaining any necessary United States or foreign regulatory approvals or clearances.Reimbursement In the United States, healthcare providers generally rely on third-party payors, principally private insurers and governmental payors such asMedicare and Medicaid, to cover and reimburse all or part of the cost of a medical procedure performed with a medical device. Our ability tocommercialize our products successfully depends in significant part on the extent to which appropriate coverage and reimbursement for our productsand related procedures are obtained from third-party payors. We cannot assure you that government or private third-party payors will cover andreimburse the procedures using our technology in whole or in part in the future or that payment rates will be adequate. Medicare coverage and reimbursement policies are particularly significant to our business. Not only is Medicare the single largest third-partypayor, but many other governmental and commercial payors follow its coverage and reimbursement policies. The Medicare coverage and reimbursementpolicies are developed by the Centers for Medicare and Medicaid Services, or CMS, the federal agency responsible for administering the Medicareprogram and its contractors. Medicare reimbursement rates for the same or similar procedures vary due to geographic location, nature of the facility inwhich the procedure is performed (e.g., teaching or community hospital) and other factors. Medicare coverage for procedures using our technology currently exists in the hospital outpatient setting and in the free-standing clinic setting. Forhospital outpatient procedures, where currently the vast majority of procedures using our CyberKnife system are performed, Medicare paymentsgenerally are made under a prospective payment system, which is based on the Ambulatory Payment Classifications, or APCs, under which proceduresare categorized. CMS assigns procedures that are comparable clinically and in terms of resources to the same APC. Hospitals are paid the applicable APC paymentrate for the outpatient procedure, regardless of the actual cost for such treatment. CMS will frequently categorize a procedure or service in a newtechnology APC where the procedure does not have sufficient claims data to be placed in an existing APC that is appropriate in terms of clinicalcharacteristics and resource costs. Once CMS has collected sufficient claims data on the procedure being paid under a new technology APC, the agencywill assign the procedure to an existing APC group. Procedures generally are reimbursed under new technology APCs for two to three years.Beginning in 2004, both planning and treatment using our CyberKnife system were assigned to new technology APCs. Medicare accomplished thisthrough certain temporary billing codes: Healthcare Common Procedure Coding System, or HCPCS, code G0338, or Linear-accelerator-basedstereotactic radiosurgery planning, HCPCS code G0339, or Image-guided robotic linear accelerator-based stereotactic radiosurgery, complete course oftherapy in one session, or first session of fractionated treatment, for the first or single treatment, and HCPCS code G0340, or Image-guided roboticlinear accelerator-based stereotactic radiosurgery, delivery including collimator changes17and custom plugging, fractionated treatment, all lesions, per session, second through fifth sessions, maximum five sessions per course of treatment, forany subsequent treatments. CMS has also determined that planning for stereotactic radiosurgery procedures using our technology should be reported using several Category ICurrent Procedure Terminology, or CPT, codes. The CPT planning codes are assigned to clinical APCs with payment levels that resulted in a slightincrease in payment in 2007 and 2008 as compared to prior years. For calendar 2009, CMS has proposed decreases in payment rates for certain CPTcodes applicable to treatment planning resulting in a cumulative decrease for treatment planning reimbursement in 2009 as compared to 2008, assumingthe proposed decreases are implemented. For 2004 to 2006, placement of HCPCS codes G0339 and G0340 in the new technology APCs resulted in a national payment rate of $5,250 forthe first treatment and $3,750 for each treatment thereafter, up to a maximum of five treatments. For 2007, CMS determined that procedures performedin the hospital outpatient department using our technology be transitioned from the new technology APCs to two clinical APCs. Under the finalizedpayment rules, the national payment rate for procedures billed using HCPCS code G0339 (for the first CyberKnife treatment) is $3,896, and proceduresbilled under HCPCS code G0340 (for each additional CyberKnife treatment) are paid $2,645. For 2008, CMS issued a final rule increasing the paymentrates for procedures billed using these codes to $3,930 and $2,871, respectively. In July 2008, CMS issued proposed payment rates under these codesfor 2009. The proposed payment rate under HCPCS code G0339 for 2009 is $3,664 and the proposed payment rate under code G0340 for 2009 is$2,654. We cannot assure you that these payment rates will be finally implemented as proposed. Medicare payment to free-standing clinics generally is based on the physician fee schedule. There are no national payment rates for HCPCS codesG0339 and G0340, and Medicare contractors determine the payment rates for their jurisdiction. We understand that some Medicare contractors mayrequire the use of other billing codes for the procedures. In addition to Medicare reimbursement to hospitals and clinics, physicians receive reimbursement for their professional services in the hospitaloutpatient setting and the free-standing clinic setting. Payment is based on the physician fee schedule, and payment amounts are updated on an annualbasis. Beginning in 2007, CMS changed how it determines payment levels under the physician fee schedule. Specifically, CMS revised themethodology for calculating the physician work component, which reflects physician time and intensity of effort in performing a procedure or service.CMS also changed its methodology for calculating the practice expense component, which reflects the overhead expenses that a physician incurs, suchas rent, equipment and salaries. We do not expect that these changes will result in any significant change in reimbursement for physician professionalservices performed in connection with the CyberKnife procedure. At this time, we cannot predict the full impact of these changes on our operations.Under proposed guidelines for 2009 Medicare reimbursements, CMS has proposed changes in payment rates for certain CPT codes applicable tophysician services that may result in increases in some areas and decreases in others. We expect that the net effect of these changes will not result insignificant changes in reimbursement for physician professional services performed in connection with the CyberKnife procedure. In July 2008, CMSrequested that the American Medical Association review approximately 100 codes for procedures that have experienced significant growth and whichhave not been recently evaluated, including certain codes used by physicians in connection with CyberKnife procedures. At this time, we cannot predictwhat the outcome of this review will be, and whether or not it will result in significant changes, either favorable or unfavorable, with respect toreimbursement for physician fees associated with CyberKnife procedures. We also cannot assure you that Medicare will continue to cover and reimburse the procedures using the CyberKnife system, or that the amountsreimbursed under applicable codes will be adequate. While private third-party payors frequently follow Medicare coverage, coding and payment18determinations, we cannot assure you that these payors will adopt coverage and reimbursement policies similar to those established by Medicare orwhether they will cover and reimburse the procedures using CyberKnife systems in whole or in part. In the United States, we believe that a majority ofprivate healthcare payors provide coverage for CyberKnife procedures under negotiated contracts with hospitals and clinics. The American Medical Association, or AMA, established four new Category I CPT codes relating to stereotactic radiosurgery, which becameeffective January 1, 2007. Third-party payors may decide to use three of these codes to describe treatment (CPT codes 77372 and 77373) and treatmentmanagement (CPT code 77435) using our technology. CMS has announced that these codes are not to be used for our technology for Medicarepayments for hospital outpatient services under the prospective payment system in 2007. These codes were assigned values for payments under theMedicare physician fee schedule for 2007 and may be required by Medicare contractors for use in other settings. CMS has again proposed that thesecodes are not to be used for our technology for Medicare payments for hospital outpatient services under the prospective payment system in 2008.Instead, CMS retained the G-codes for use in these settings in 2008. The extent to which any of these new codes would be required in the future byMedicare contractors for services using our technology and performed in free-standing clinics or by other third-party payors is unclear. It is also unclearat this time whether or for how long the new codes will continue to coexist with or replace the existing codes for treatment using our technology(HCPCS codes G0339 and G0340) and how the level of reimbursement would be impacted by the new codes. If Medicare contractors begin to requirethe use of the new codes for 2008 or 2009, the reimbursement rates for CPT codes 77372 and 77373 under the final 2008 and proposed 2009 Medicarephysician fee schedule could result in a material adverse effect on our business. AMA has also recently issued guidance that CPT code 61793, which isa code describing neurosurgical services, should be used for intracranial and spinal procedures only. This has created some potential uncertainty forphysicians performing extracranial CyberKnife procedures, as their alternative method of billing for these procedures would be to use unlisted codes. Inaddition to 61793, Medicare administrators in certain geographic regions have recommended the use of unlisted codes for certain physicians to describeextracranial SRS procedures. The inability of physicians to obtain reimbursement under CPT code 61793 or any related unlisted or successor CPT codecould result in a material adverse effect on our business. The current emphasis on cost-containment by third-party payors makes it exceedingly difficult for new medical devices and surgical procedures toobtain adequate coverage and reimbursement. Often, it is necessary to convince these payors that the new devices or procedures will establish an overallcost savings compared to currently reimbursed devices and procedures. We believe that the CyberKnife system may offer an opportunity for payors toreduce the cost of treatment for solid tumors as compared with surgical removal; however, we cannot assure you that payors will agree that theseadvantages exist or that payors will make reimbursement decisions based upon any such advantages. Hospitals would be less likely to purchase ourproducts if they do not receive sufficient levels of reimbursement. In addition, if physicians or hospital administrators believe that our system will addcost to a procedure but will not add sufficient offsetting economic or clinical benefits, physician adoption could be impaired. Any reduction or limitationin use of our products could cause our sales to suffer. Reimbursement by third-party payors is often positively influenced by the existence of peer-reviewed publications of long-term safety and efficacydata. We have collected and published data on clinical results for patients that have undergone surgical procedures involving use of the CyberKnifesystem, although we do not yet have long-term safety and efficacy data for a significant patient population size. We cannot assure you that our productswill continue to be covered and reimbursed without publication of additional data, including data supporting long-term safety and efficacy of theCyberKnife system.19 We have established a dedicated health policy and reimbursement group that seeks to provide education to physicians and facilities in working withpayors on coverage and reimbursement issues for procedures involving the use of the CyberKnife system. This group assists with reimbursementapplication processes worldwide in significant markets for the CyberKnife system and provides our customers with copies of relevant coverage, codingand payment policies, including those of the Medicare program, as well as published literature and clinical data supporting clinical safety and efficacy inthe device. To further support adequate coverage and reimbursement, a group of customers has formally organized into a non-profit organization to pursuepatient access to the CyberKnife technology, adequate reimbursement, coverage and payment of our product, with a strong emphasis on the UnitedStates. This group, the CyberKnife Coalition, has a charter to promote patient access to CyberKnife system technology and treatment, and realizeadequate coverage and reimbursement to support that treatment. The CyberKnife Coalition seeks to assure and advocate that procedures using theCyberKnife system continue to be reimbursed at appropriate levels by Medicare and other third-party payors. Internationally, reimbursement and healthcare payment systems vary substantially from country to country and include single-payor, governmentmanaged systems as well as systems in which private payors and government-managed systems exist side-by-side. In addition, in many internationalmarkets, consumers of healthcare services, particularly services involving new or specialized technology, may pay out-of-pocket for such services. Ourability to achieve market acceptance or significant sales volume in international markets we enter will be dependent in large part on the availability ofreimbursement for procedures performed using our products under healthcare payment systems in such markets. To date, healthcare providers inEurope and in Asian markets with installed CyberKnife systems have been able to successfully negotiate coverage contracts with their local payors atadequate payment rates.Regulatory MattersDomestic Regulation Our products and software are medical devices subject to regulation by the U.S. Food and Drug Administration, or FDA, as well as otherregulatory bodies. FDA regulations govern the following activities that we perform and will continue to perform to ensure that medical productsdistributed domestically or exported internationally are safe and effective for their intended uses:•product design and development; •document and purchasing controls; •production and process controls; •acceptance controls; •product testing; •product manufacturing; •product safety; •product labeling; •product storage; •recordkeeping; •complaint handling; •pre-market clearance or approval;20•advertising and promotion; and •product sales and distribution. FDA pre-market clearance and approval requirements. Unless an exemption applies, each medical device we wish to commercially distributein the United States will require either prior 510(k) clearance or pre-market approval from the FDA. The FDA classifies medical devices into one ofthree classes. Devices deemed to pose lower risks are placed in either class I or II, which requires the manufacturer to submit to the FDA a pre-marketnotification requesting permission to commercially distribute the device. This process is generally known as 510(k) clearance. Some low risk devicesare exempted from this requirement. Devices deemed by the FDA to pose the greatest risks, such as life-sustaining, life-supporting or implantabledevices, or devices deemed not substantially equivalent to a previously cleared 510(k) device, are placed in class III, requiring pre-market approval. Allof our current products are class II devices. 510(k) clearance pathway. When a 510(k) clearance is required, we must submit a pre-market notification demonstrating that our proposeddevice is substantially equivalent to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for whichthe FDA has not yet called for the submission of pre-market approval applications, or PMA. By regulation, the FDA is required to clear or deny a510(k) pre-market notification within 90 days of submission of the application. As a practical matter, clearance may take longer. The FDA may requirefurther information, including clinical data, to make a determination regarding substantial equivalence. In July 1999, we received 510(k) clearance for the CyberKnife system for use in the head and neck regions of the body. In August 2001, wereceived 510(k) clearance for the CyberKnife system to provide treatment planning and image guided stereotactic radiosurgery and precisionradiotherapy for lesions, tumors and conditions anywhere in the body where radiation treatment is indicated. In April 2002, we received 510(k)clearance for the Synchrony Motion Tracking System as an option to the CyberKnife system, intended to enable dynamic image guided stereotacticradiosurgery and precision radiotherapy of lesions, tumors and conditions that move under influence of respiration. Pre-market approval (PMA) pathway. A PMA must be submitted to the FDA if the device cannot be cleared through the 510(k) process. APMA must be supported by extensive data, including but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrateto the FDA's satisfaction the safety and effectiveness of the device. No device that we have developed has required pre-market approval, nor do wecurrently expect that any future device or indication will require pre-market approval. Product modifications. After a device receives 510(k) clearance or a PMA, any modification that could significantly affect its safety oreffectiveness, or that would constitute a significant change in its intended use, will require a new clearance or approval. We have modified aspects of ourCyberKnife system family of products since receiving regulatory clearance, and we have applied for and obtained additional 510(k) clearances for thesemodifications when we determined such clearances were required for the modifications. The FDA requires each manufacturer to make thisdetermination initially, but the FDA can review any such decision and can disagree with a manufacturer's determination. If the FDA disagrees with ourdetermination not to seek a new 510(k) clearance or PMA, the FDA may retroactively require us to seek 510(k) clearance or pre-market approval. TheFDA could also require us to cease marketing and distribution and/or recall the modified device until 510(k) clearance or pre-market approval isobtained. Also, in these circumstances, we may be subject to significant regulatory fines or penalties. During our fiscal year ended June 30, 2008, wesubmitted an additional two 510(k) clearances notifications for modifications made to the operation of the CyberKnife system. These applications werecleared by the FDA.21 Pervasive and continuing regulation. After a device is placed on the market, numerous regulatory requirements apply. These include:•Quality System Regulation, or QSR, which require manufacturers, including third-party manufacturers, to follow stringent design,testing, control, documentation and other quality assurance procedures during product design and throughout the manufacturing process;•labeling regulations and FDA prohibitions against the promotion of products for uncleared, unapproved or off-label uses; and •medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributedto a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunctionwere to recur. The FDA has broad post-market and regulatory enforcement powers. We are subject to unannounced inspections by the FDA and the Food andDrug Branch of the California Department of Health Services to determine our compliance with the QSR and other regulations, and these inspectionsmay include the manufacturing facilities of some of our subcontractors. In the past, our prior facility has been inspected, and observations were noted.In May 2004 and April 2006, during routine inspections performed by the FDA, two minor observations were made in each inspection. We have takencorrective action on the minor observations in response to the FDA's observations. There were no observations that involved a material violation ofregulatory requirements. We believe that we are in substantial compliance with the QSR. In February 2007, during routine inspections performed by theFDA of one of our manufacturing facilities, no observations were made. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the followingsanctions:•fines, injunctions, consent decrees and civil penalties; •recall or seizure of our products; •operating restrictions, partial suspension or total shutdown of production; •refusing our requests for 510(k) clearance or pre-market approval of new products or new intended uses; •withdrawing 510(k) clearance or pre-market approvals that are already granted; and •criminal prosecution. The FDA also has the authority to require us to repair, replace or refund the cost of any medical device that we have manufactured or distributed. Ifany of these events were to occur, they could have a material adverse effect on our business. Radiological health. Because our CyberKnife system contains both laser and X-ray components, and because we assemble these componentsduring manufacturing and service activities, we are also regulated under the Electronic Product Radiation Control Provisions of the Federal Food, Drug,and Cosmetic Act. This law requires laser and X-ray products to comply with regulations and applicable performance standards, and manufacturers ofthese products to certify in product labeling and reports to the FDA that their products comply with all such standards. The law also requiresmanufacturers to file new product reports, and to file annual reports and maintain manufacturing, testing and sales records, and report product defects.Various warning labels must be affixed. Assemblers of diagnostic X-ray systems are also required to certify in reports to the FDA, equipmentpurchasers, and where applicable, to state agencies responsible for radiation protection, that diagnostic and/or therapeutic X-ray systems they assemblemeet applicable requirements. Failure to comply with these requirements22could result in enforcement action by the FDA, which can include injunctions, civil penalties, and the issuance of warning letters. In the past, we failedto submit required reports to the FDA in a timely fashion. To correct our reporting deficiencies, in 2003 we initiated a corrective action plan thatincluded, among other things, filing all past due reports with the FDA, applicable state agencies, and customers. We have also developed andimplemented procedures to ensure future reports are made in a timely manner. While we believe all past reporting deficiencies have been corrected, wecannot assure you that FDA will deem our corrective actions sufficient or that FDA will not initiate enforcement action against us.Fraud and Abuse Laws We are subject to various federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referrallaws. Violations of these laws are punishable by significant criminal and civil sanctions, including, in some instances, exclusion from participation infederal and state healthcare programs, including Medicare and Medicaid. Because of the far-reaching nature of these laws, there can be no assurance thatwe would not be required to alter one or more of our practices to be in compliance with these laws. Evolving interpretations of current laws, or theadoption of new federal or state laws or regulations could adversely affect many of the arrangements we have with customers and physicians. Inaddition, there can be no assurance that the occurrence of one or more violations of these laws or regulations would not result in a material adverseeffect on our financial condition and results of operations. Anti-kickback laws. Our operations are subject to broad and changing federal and state anti-kickback laws. The Office of the Inspector Generalof the Department of Health and Human Services, or the OIG, is primarily responsible for enforcing the federal Anti-Kickback Statute and generally foridentifying fraud and abuse activities affecting government programs. The federal Anti-Kickback Statute prohibits persons from knowingly andwillfully soliciting, receiving, offering or providing remuneration directly or indirectly to induce either the referral of an individual, or the furnishing,recommending, or arranging of a good or service, for which payment may be made under a federal healthcare program such as Medicare and Medicaid."Remuneration" has been broadly interpreted to include anything of value, including such items as gifts, discounts, the furnishing of supplies orequipment, credit arrangements, waiver of payments, and providing anything of value at less than fair market value. Penalties for violating the federal Anti-Kickback Statute include criminal fines of up to $25,000 and/or imprisonment for up to five years for eachviolation, civil fines of up to $50,000 and possible exclusion from participation in federal healthcare programs such as Medicare and Medicaid. Manystates have adopted prohibitions similar to the federal Anti-Kickback Statute, some of which apply to the referral of patients for healthcare servicesreimbursed by any source, not only by the Medicare and Medicaid programs, and do not include comparable exceptions. The Office of the Inspector General of the Department of Health and Human Services, or OIG, has issued safe harbor regulations which set forthcertain activities and business relationships that are deemed safe from prosecution under the federal Anti-Kickback Statute. There are safe harbors forvarious types of arrangements, including, without limitation, certain investment interests, leases and personal services and management contracts. Thefailure of a particular activity to comply in all regards with the safe harbor regulations does not mean that the activity violates the federal Anti-KickbackStatute or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may resultin increased scrutiny by government enforcement authorities such as the OIG.23 The OIG has identified the following arrangements with purchasers and their agents as ones raising potential risk of violation of the federal Anti-Kickback Statute:•Discount and free good arrangements that are not properly disclosed or accurately reported to federal healthcare programs; •Product support services, including billing assistance, reimbursement consultation and other services specifically tied to support of thepurchased product, offered in tandem with another service or program (such as a reimbursement guarantee) that confers a benefit to thepurchaser; •Educational grants conditioned in whole or in part on the purchase of equipment, or otherwise inappropriately influenced by sales andmarketing considerations; •Research funding arrangements, particularly post-marketing research activities, that are linked directly or indirectly to the purchase ofproducts, or otherwise inappropriately influenced by sales and marketing considerations; and •Other offers of remuneration to purchasers that are expressly or impliedly related to a sale or sales volume, such as "prebates" and"upfront payments," other free or reduced-price goods or services, and payments to cover costs of "converting" from a competitor'sproducts, particularly where the selection criteria for such offers vary with the volume or value of business generated. We have a variety of financial relationships with physicians who are in a position to generate business for us. For example, physicians own ourstock who also provide medical advisory and other consulting and personal services. Similarly, we have a variety of different types of arrangementswith our customers. For example, our shared ownership program entails the provision of our CyberKnife system to our customers under a deferredpayment program, where we generally receive the greater of a fixed minimum payment or a portion of the service revenues. Included in the fee wecharge for the shared ownership program are a variety of services, including physician training, educational and marketing support, generalreimbursement guidance and technical support. In the case of our former placement program, certain services and upgrades were provided withoutadditional charge based on procedure volume. In the past, we have also provided loans to our customers. We also provide research grants to customersto support customer studies related to, among other things, our CyberKnife systems. If our past or present operations are found to be in violation of the federal Anti-Kickback Statute or similar government regulations to which we orour customers are subject, we or our officers may be subject to the applicable penalty associated with the violation, including significant civil andcriminal penalties, damages, fines, imprisonment, and exclusion from the Medicare and Medicaid programs. The impact of any such violation may leadto curtailment or restructuring of our operations. Any penalties, damages, fines, or curtailment or restructuring of our operations could adversely affectour ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that some ofthese laws are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, couldcause us to incur significant legal expenses, divert our management's attention from the operation of our business and damage our reputation. If anenforcement action were to occur, our reputation and our business and financial condition could be harmed, even if we were to prevail or settle theaction. Similarly, if the physicians or other providers or entities with whom we do business are found to be non-compliant with applicable laws, theymay be subject to sanctions, which could also have a negative impact on our business. Physician self-referral laws. We are also subject to federal and state physician self-referral laws. The federal Ethics in Patient Referral Act of1989, commonly known as the Stark Law, prohibits, subject to certain exceptions, physician referrals of Medicare and Medicaid patients to an entityproviding certain "designated health services" if the physician or an immediate family member has any financial relationship with the entity. The StarkLaw also prohibits the entity receiving the referral from billing any good or service furnished pursuant to an unlawful referral.24 In addition, in connection with the release in July 2007 of proposed Medicare reimbursement rates for calendar 2008, CMS proposed significantamendments to the regulations under the federal Ethics in Patient Referrals Act, which is more commonly known as the Stark Law. These proposedregulations would, among other things, impose additional limitations on the ability of physicians to refer patients to medical facilities in which thephysician has an ownership interest for treatment. Among other things, the regulations provide that leases of equipment between physician owners thatmay refer patients and hospitals must be on a fixed rate, rather than a per use, basis. Physician owned entities have increasingly become involved in theacquisition of medical technologies, including the CyberKnife system. In many cases, these entities enter into arrangements with hospitals that billMedicare for the furnishing of medical services, and the physician owners are among the physicians who refer patients to the entity for services. Theregulations, as originally proposed, would limit these arrangements and could require the restructuring of existing arrangements between physiciansowned entities and hospitals and may also discourage physicians from participating in the acquisition and ownership of medical technologies. In July2008, at the time CMS published final 2008 Medicare in-patient reimbursement rates, CMS issued a final rule essentially implementing the regulationsin substantially the manner originally proposed, with an effective date of October 1, 2009. Among other prohibitons, the final rule prohibits percentage-based compensation in equipment leases. As a result of the finalization of these regulations, some existing CyberKnife system operators may have tomodify or restructure their corporate or organizational structures. In addition, certain existing customers that planned to open CyberKnife centers in theUnited States involving physician ownership could also have to restructure prior to the October 2009 effective date of the new regulations. It is possiblethat some of these entities may not be able to establish viable models for CyberKnife system operation and may therefore cancel their CyberKnifesystem purchase agreements. Accordingly, these new regulations could result in cancellations of existing CyberKnife system purchase agreements andcould also reduce the attractiveness of medical technology acquisitions, including CyberKnife system purchases, by physician-owned joint ventures orsimilar entities. As a result, these regulations could have an adverse impact on our product sales and therefore on our business and results of operations. A person who engages in a scheme to circumvent the Stark Law's referral prohibition may be fined up to $100,000 for each such arrangement orscheme. In addition, any person who presents or causes to be presented a claim to the Medicare or Medicaid programs in violation of the Stark Law issubject to civil monetary penalties of up to $15,000 per bill submission, an assessment of up to three times the amount claimed, and possible exclusionfrom federal healthcare programs such as Medicare and Medicaid. Various states have corollary laws to the Stark Law, including laws that requirephysicians to disclose any financial interest they may have with a healthcare provider to their patients when referring patients to that provider. Both thescope and exceptions for such laws vary from state to state. Federal False Claims Act. The federal False Claims Act prohibits the knowing filing or causing the filing of a false claim or the knowing use offalse statements to obtain payment from the federal government. When an entity is determined to have violated the False Claims Act, it must pay threetimes the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim.Suits filed under the False Claims Act, known as "qui tam" actions, can be brought by any individual on behalf of the government and such individuals,sometimes known as "relators" or, more commonly, as "whistleblowers", may share in any amounts paid by the entity to the government in fines orsettlement. In addition, certain states have enacted laws modeled after the federal False Claims Act. Qui tam actions have increased significantly in recentyears, causing greater numbers of healthcare companies to have to defend a false claim action, pay fines or be excluded from Medicare, Medicaid orother federal or state healthcare programs as a result of an investigation arising out of such action. We have retained the services of a reimbursementconsultant, for which we pay certain consulting fees, to provide us and facilities that have purchased a CyberKnife system or acquired a CyberKnifesystem through our shared ownership program with25general reimbursement advice. While we believe this will assist our customers in filing proper claims for reimbursement and such consultants do notsubmit claims on behalf of our customers, the fact that we provide these consultant services could expose us to additional scrutiny and possible liabilityin the event one of our customers is investigated as a result of any of these laws. HIPAA. The Health Insurance Portability and Accountability Act of 1996, or HIPAA, created two new federal crimes: healthcare fraud andfalse statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud anyhealthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion fromgovernment sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact ormaking any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. Aviolation of this statute is a felony and may result in fines or imprisonment.International Regulation International sales of medical devices are subject to foreign government regulations, which vary substantially from country to country. The timerequired to obtain clearance or approval by a foreign country may be longer or shorter than that required for FDA clearance or approval, and therequirements may be different. The primary regulatory environment in Europe is that of the European Union and the three additional member states of the European EconomicArea, or EEA, which have adopted similar laws and regulations with respect to medical devices. The European Union has adopted numerous directivesand the European Committee for Standardization has promulgated standards regulating the design, manufacture, clinical trials, labeling and adverseevent reporting for medical devices. Devices that comply with the requirements of the relevant directive will be entitled to bear CE conformity marking,indicating that the device conforms with the essential requirements of the applicable directives and, accordingly, may be commercially distributedthroughout the member states of the European Economic Area. The method of assessing conformity to applicable standards and directives depends on the type and class of the product, but normally involves acombination of self-assessment by the manufacturer and a third-party assessment by a notified body, an independent and neutral institution appointed bya European Union member state to conduct the conformity assessment. This relevant assessment may consist of an audit of the manufacturer's qualitysystem (currently ISO 13485), provisions of the Medical Devices Directive, and specific testing of the manufacturer's device. In September 2002, ourfacility was awarded the ISO 13485 certification, which replaces the ISO 9001 and EN 46001 approvals, which has been subsequently maintainedthrough periodic assessments, in accordance with the expiration dates of the standards, and we are currently authorized to affix the CE mark to ourproducts, allowing us to sell our products throughout the European Economic Area. We are also currently subject to regulations in Japan. A Japanese distributor received the first government approval to market the CyberKnifesystem from the Ministry of Health and Welfare, or MHLW, in November 1996. In December, 2003, we received approval from the MHLW to marketthe CyberKnife system in Japan for clinical applications in the head and neck, and a new distributor, Chiyoda Technol Corporation, was appointed todistribute the CyberKnife system. In June 2008, we received approval from the MHLW to market the CyberKnife system for treatments throughout thebody where radiation treatment is indicated. We are subject to additional regulations in other foreign countries, including, but not limited to, Canada, Taiwan, China and Korea, in order to sellour products. We intend that either we or our distributors will receive any necessary approvals or clearance prior to marketing our products in those26international markets. In China, the CyberKnife system is being assessed by the Ministry of Health, which regulates the operation of certain types ofmedical capital equipment products and systems by hospitals in the public civilian health care system. Until this review is complete, our ability to sellsystems to public civilian hospitals in China will be constrained.State Certificate of Need Laws In some states, a certificate of need or similar regulatory approval is required prior to the acquisition of high-cost capital items or the provision ofnew services. These laws generally require appropriate state agency determination of public need and approval prior to the acquisition of such capitalitems or addition of new services. Certificate of need regulations may preclude our customers from acquiring the CyberKnife system, whether throughpurchase or our shared ownership program, and from performing stereotactic radiosurgery procedures using the CyberKnife system. Several of ourprospective customers currently are involved in appeals of certificate of need determinations. If these appeals are not resolved in favor of theseprospective customers, they may be precluded from purchasing and/or performing services using the CyberKnife system. Certificate of need laws arethe subject of continuing legislative activity, and a significant increase in the number of states regulating the acquisition and use of the CyberKnifesystem through certificate of need or similar programs could adversely affect us.Employees As of June 30, 2008, we had 504 employees worldwide, including 139 in research and development, 126 in sales and marketing, 96 in installationand service, 42 in manufacturing, and 101 in administration. None of the employees are represented by a labor union or is covered by a collectivebargaining agreement. We have never experienced any employment-related work stoppages and we believe our relationship with our employees is good.Item 1A. Risk Factors Risks Related to Our BusinessWe have a large accumulated deficit, may expect future losses and may be unable to maintain profitability. We have incurred net losses in every fiscal year since our inception except during the fiscal year ended June 30, 2008. As of June 30, 2008, wehad an accumulated deficit of $121.1 million. We may incur net losses in the future, particularly as we increase our manufacturing, sales and marketingand administrative activities and as we continue our research and development activities. Our ability to maintain long-term profitability is largelydependent on our ability to successfully market and sell the CyberKnife system and to control our costs and effectively manage our growth. We arerequired to defer revenue associated with our legacy multiyear service plans due to specified obligations related to the delivery of upgrades to theCyberKnife system. Although we anticipate our deferred revenue will continue to decline in future periods, we may not be able to recognize someportions of our deferred revenue until we have satisfied all obligations for delivery of upgrades. We cannot assure you that we will be able to maintainprofitability. In the event we fail to maintain profitability, our stock price could decline.If the CyberKnife system does not achieve widespread market acceptance, we will not be able to generate the revenue necessary to support ourbusiness. Achieving physician, patient, hospital administrator and third-party payor acceptance of the CyberKnife system as a preferred method of tumortreatment will be crucial to our continued success. Physicians will not begin to use or increase the use of the CyberKnife system unless they determine,based on experience, clinical data and other factors, that the CyberKnife system is a safe and effective27alternative to current treatment methods. The CyberKnife system was initially used primarily for the treatment of tumors in the brain, and the broader useof the system to treat tumors elsewhere in the body has been a more recent development. As a result, physician and patient acceptance of the CyberKnifesystem as a comprehensive tool for treatment of solid tumor cancers anywhere in the body has not yet been fully demonstrated, particularly as comparedto products, systems or technologies that have longer histories in the marketplace. The CyberKnife system is a major capital purchase and purchasedecisions are greatly influenced by hospital administrators who are subject to increasing pressures to reduce costs. These and other factors may affectthe rate and level of the CyberKnife system's market acceptance, including:•the CyberKnife system's price relative to other products or competing treatments; •effectiveness of our sales and marketing efforts; •capital equipment budgets of healthcare institutions; •perception by physicians and other members of the healthcare community of the CyberKnife system's safety, efficacy and benefitscompared to competing technologies or treatments; •publication in peer-reviewed medical journals of data regarding the successful use and longer term clinical benefits of the CyberKnifesystem; •willingness of physicians to adopt new techniques and the ability of physicians to acquire the skills necessary to operate the CyberKnifesystem; •extent of third-party coverage and reimbursement for procedures using the CyberKnife system; •development of new products and technologies by our competitors or new treatment alternatives; •regulatory developments related to manufacturing, marketing and selling the CyberKnife system both within and outside the UnitedStates; •perceived liability risks arising from the use of new products; and •unfavorable publicity concerning the CyberKnife system or radiation-based treatment alternatives. If the CyberKnife system is unable to achieve or maintain market acceptance, our business would be harmed.The high unit price of the CyberKnife system, as well as other factors may contribute to substantial fluctuations in our operating results. Because of the high unit price of the CyberKnife system, and the relatively small number of units installed each quarter, each installation of aCyberKnife system can represent a significant component of our revenue for a particular quarter. Therefore, if we do not install a CyberKnife systemwhen anticipated, our operating results may vary significantly. These fluctuations and other potential fluctuations mean that you should not rely uponour operating results in any particular period as an indication of future performance. In particular, factors which may contribute to these fluctuations mayinclude:•timing of when we are able to recognize revenue associated with sales of the CyberKnife system, which varies depending upon the termsof the applicable sales and service contracts; •the proportion of revenue attributable to purchases of the CyberKnife system, our shared ownership program and installations associatedwith our legacy service plans; •timing and level of expenditures associated with new product development activities;28•regulatory requirements in some states for a certificate of need prior to the installation of a radiation device; •delays in shipment due, for example, to unanticipated construction delays at customer locations where our products are to be installed,cancellations by customers, natural disasters or labor disturbances; •delays in our manufacturing processes or unexpected manufacturing difficulties; •timing of the announcement, introduction and delivery of new products or product upgrades by us and by our competitors; •timing and level of expenditures associated with expansion of sales and marketing activities such as trade shows and our overalloperations; •disruptions in the supply or changes in the costs of raw materials, labor, product components or transportation services; and •changes in third party coverage and reimbursement, changes in government regulation, or a change in a customer's financial condition orability to obtain financing. These factors are difficult to forecast and may contribute to substantial fluctuations in our quarterly revenues and substantial variation from ourprojections, particularly during the periods in which our sales volume is low.We experience a long and variable sales and installation cycle, which may result in inconsistent quarterly results. The CyberKnife system has a lengthy sales and purchase order cycle because it is a major capital equipment item and requires the approval ofsenior management at purchasing institutions. The sales process in the United States typically begins with pre-selling activity followed by salespresentations and other sales-related activities. After the customer has expressed an intention to purchase a CyberKnife system, we negotiate and enterinto a definitive purchase contract with the customer. This may take the form of a terms agreement setting forth the business and economic terms of thetransaction. Generally following the execution of the contract, the customer begins the building or renovation of a facility to house the CyberKnifesystem, which together with the subsequent installation of the CyberKnife system, can take up to 24 months to complete. During the period prior toinstallation, the customer must build a radiation-shielded facility to house its CyberKnife system. In order to construct this facility, the customer musttypically obtain radiation device installation permits, which are granted by state and local government bodies, each of which may have different criteriafor permit issuance. If a permit were denied for installation at a specific hospital or treatment center, our CyberKnife system could not be installed at thatlocation. In addition, some of our customers are cancer centers or facilities that are new, and in these cases it may be necessary for the entire facility tobe completed before the CyberKnife system can be installed, which can result in additional construction and installation delays. Under our revenue recognition policy, we generally do not recognize revenue attributable to a CyberKnife system purchase until after installationhas occurred. For international sales through distributors, we typically recognize revenue when the system is delivered to the end user's site. Thereforethe long sales cycle together with the timing of CyberKnife system shipments and installations may result in significant fluctuations in our reporting ofquarterly revenues. Under our current forms of purchase and service contracts, we receive a majority of the purchase price for the CyberKnife systemupon installation of the system. Events beyond our control may delay installation and the satisfaction of contingencies required to receive cash inflowsand recognize revenue, such as:•procurement delay;29•customer funding or financing delay; •delay in or unforeseen difficulties related to customers organizing legal entities and obtaining financing for CyberKnife systemacquisition; •construction delay; •delay pending customer receipt of a building or radiation device installation permit; and •delay caused by weather or natural disaster. In the event that a customer does not, for any of the reasons above or other reasons proceed with installation of the system after entering into apurchase contract, we would only recognize up to the deposit portion of the purchase price as revenue, unless the deposit was refunded to the customer.Therefore, delays in the installation of CyberKnife systems or customer cancellations would adversely affect our cash flows and revenue, which wouldharm our results of operations.Current credit and financial market conditions could delay, or prevent our customers from obtaining financing to purchase the CyberKnifesystem, which would adversely affect our business, financial condition and results of operations. Due to the recent tightening of credit markets and concerns regarding the availability of credit, particularly in the United States, our customers maybe delayed in obtaining, or may not be able to obtain, necessary financing for their purchases of the CyberKnife system or for the construction orrenovation of facilities to house CyberKnife systems. To date, these delays have primarily affected customers that were planning on operating free-standing CyberKnife systems, rather than hospital-based customers. These delays have in some instances led to our customers postponing the shipmentand installation of previously ordered systems or cancelling their system orders and may cause other customers to postpone their system installation orto cancel their agreements with us. An increase in delays and order cancellations of this nature would adversely affect our product sales and revenues,and therefore harm our business and results of operations.If third-party payors do not continue to provide sufficient coverage and reimbursement to healthcare providers for use of the CyberKnife system,our revenue would be adversely affected. Our ability to commercialize our products successfully will depend in significant part on the extent to which appropriate coverage andreimbursement for our products and related procedures are obtained from third-party payors, including governmental payors such as Medicare. Third-party payors, and in particular managed care organizations, are increasingly challenging the prices charged for medical products and services andinstituting cost containment measures to control or significantly influence the purchase of medical products and services. These cost containmentmeasures, if instituted in a manner affecting the coverage for or payment of our products could have a material adverse effect on our operating results. Uncertainty exists as to the coverage and reimbursement status of new medical products and services and new indications for existing products.The CyberKnife procedure is currently covered and reimbursed by Medicare and other governmental and non-governmental third-party payors.However, we cannot assure you that the CyberKnife procedure will continue to be reimbursed at current rates or that third-party payors will continue toconsider our products cost-effective relative to other treatments and provide coverage and reimbursement for our products, in whole or in part. For2007, under the finalized Medicare payment rules, the national payment rates for procedures billed using these codes are $3,896 for the first treatmentand $2,645 for each treatment thereafter, up to a maximum of five total treatments. For 2008, CMS issued a final rule increasing the payment rates forprocedures billed using these codes to $3,930 and $2,871, respectively. In July 2008, CMS issued proposed payment rates under these codes for 2009.The proposed 2009 payment rate for the initial treatment is $3,664 and the30proposed payment rate for subsequent treatments (up to a maximum of five total treatments) is $2,654. We cannot assure you that these payment rateswill be finally implemented as proposed. In addition, for 2008, CMS promulgated new regulations that recognize payment for our CyberKnife system in the ambulatory surgical center, orASC, setting. In a final rule displayed on November 1, 2007, CMS provides for payment for approximately 790 additional surgical procedures thatwere previously not covered in this setting. CMS will pay separately for certain covered ancillary services that are provided integral to covered surgicalprocedures in ASCs. The ancillary services must be provided immediately before, during, or after a covered surgical procedure to be considered integraland therefore, eligible for separate payment. Codes describing our CyberKnife procedure are included in a list of "Radiology services paid separatelywhen provided integral to a surgical procedure" in the final ASC rule and, effective 2008, would be paid at $2,554 for the first treatment and $1,866 foreach subsequent treatment under this rule when performed in the ASC setting. Uncertainties remain relating to the application of the new ASCregulations to CyberKnife procedures, however. In particular, procedures using our technology are rarely if ever performed integral to other surgicalprocedures. Therefore, it is unclear whether and to what extent any CyberKnife procedure will be reimbursed in the ASC setting or whether theprocedure would be recognized as covered in this setting by Medicare contractors. A downward adjustment in reimbursement could have a materialadverse effect on our operations. Billing codes for stereotactic radiosurgery have been established by the American Medical Association, effective 2007. CMS has determined thatthese codes are not to be used for hospital outpatient claims under the prospective payment system for 2007 and, instead, existing billing codes for ourtechnology continue to be in effect. It appears that the billing codes established by the American Medical Association generally are not being used fortreatments using the CyberKnife system in non-hospital settings, or free-standing clinic settings, as well. It remains unclear how these billing codes willbe used for procedures in other settings for Medicare purposes or how they will be used by non-Medicare payors in the future. Payment amounts for2007 under the Medicare physician fee schedule for freestanding clinic settings may result in a decrease from current payment amounts if these codesare required for billing our technology. Physicians, hospitals and other healthcare providers may be reluctant to purchase the CyberKnife system or maydecline to do so entirely if they determine there is not sufficient coverage and reimbursement from third-party payors for the cost of the CyberKnifeprocedure. In addition, if physicians or hospital administrators believe that our CyberKnife system will add costs to a procedure, but will not addsufficient offsetting economic or clinical benefits, adoption could be impaired. Any reduction or limitation in use of the CyberKnife system could havean adverse impact on our sales. Our success in international markets also depends upon the eligibility of reimbursement for the CyberKnife procedure through government-sponsored healthcare payment systems and third-party payors. Reimbursement and healthcare payment systems in international markets varysignificantly by country and, within some countries, by region. In many international markets, payment systems may control reimbursement forprocedures performed using new products as well as procurement of these products. In addition, as economies of emerging markets develop, thesecountries may implement changes in their healthcare delivery and payment systems. Furthermore, healthcare cost containment efforts similar to thoseunderway in the United States are prevalent in many of the other countries in which we intend to sell our products and these efforts are expected tocontinue. Market acceptance of our products in a particular country may depend on the availability and level of reimbursement in that country. In theevent that our customers are unable to obtain adequate reimbursement for the CyberKnife procedures in international markets in which we are selling, orare seeking to sell, CyberKnife systems, market acceptance of our products would be adversely affected.31Future legislative or regulatory changes to the healthcare system may affect our business. Even if third-party payors provide adequate coverage and reimbursement for the CyberKnife procedure, adverse changes in third-party payors'general policies toward reimbursement could preclude market acceptance for our products and materially harm our sales and revenue growth. In theUnited States, there have been, and we expect there will continue to be, a number of legislative and regulatory changes and proposals to change thehealthcare system, and some could involve changes that significantly affect our business. For instance, on December 8, 2003, President George W.Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003, which, among other things, established a newprescription drug benefit and changed reimbursement methodologies for drugs and devices used in hospital outpatient departments and in the home. Inaddition, certain federal regulatory changes occur at least annually. CMS has determined that treatments in hospital outpatient departments using ourtechnology will no longer be assigned a new technology classification and, instead, will be transitioned to a classification that would result in a reductionin Medicare payments to hospitals. Further, the billing codes that went into effect in 2007 may be required by third-party payors in the future and mayresult in a decrease in payments for services using our technology. A downward adjustment in reimbursement could have a material adverse effect onour operations. In addition, in connection with the release in July 2007 of proposed Medicare reimbursement rates for calendar 2008, CMS proposed significantamendments to the regulations under the federal Ethics in Patient Referrals Act, which is more commonly known as the Stark Law. These proposedregulations would, among other things, impose additional limitations on the ability of physicians to refer patients to medical facilities in which thephysician has an ownership interest for treatment. Among other things, the regulations provide that leases of equipment between physician owners thatmay refer patients and hospitals must be on a fixed rate, rather than a per use, basis. Physician owned entities have increasingly become involved in theacquisition of medical technologies, including the CyberKnife system. In many cases, these entities enter into arrangements with hospitals that billMedicare for the furnishing of medical services, and the physician owners are among the physicians who refer patients to the entity for services. Theregulations, as originally proposed, would limit these arrangements and could require the restructuring of existing arrangements between physiciansowned entities and hospitals and may also discourage physicians from participating in the acquisition and ownership of medical technologies. In July2008, at the time CMS published final 2008 Medicare in-patient reimbursement rates, CMS issued final rules essentially implementing the regulations insubstantially the manner originally proposed, with an effective date of October 1, 2009. As a result of the finalization of these regulations, some existingCyberKnife system operators may have to modify or restructure their corporate or organizational structures. In addition, certain existing customers thatplanned to open CyberKnife centers in the United States involving physician ownership could also have to restructure prior to the October 2009effective date of the new regulations. It is possible that some of these entities may not be able to establish viable models for CyberKnife systemoperation and may therefore cancel their CyberKnife system purchase agreements. Accordingly, these new regulations could result in cancellations ofexisting CyberKnife system purchase agreements and could also reduce the attractiveness of medical technology acquisitions, including CyberKnifesystem purchases, by physician-owned joint ventures or similar entities. As a result, these regulations could have an adverse impact on our productsales and therefore on our business and results of operations. Future legislative or policy initiatives directed at reducing costs could be introduced at either the federal or state level. We cannot predict the impacton our business of any legislation or regulations related to the healthcare system that may be enacted or adopted in the future.32Our evaluation of our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act identified a material weakness inour internal controls and if we are unable to remedy this weakness or if additional weaknesses are identified in future periods, our business andour stock price could be adversely affected. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, beginning with this Annual Report on Form 10-K for the fiscal yearended June 30, 2008, we are required to furnish a report by our management on our internal control over financial reporting and whether such controlsare deemed effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified bymanagement. The report must also contain a statement that our auditors have issued an attestation report on our internal controls. We were not able to assert, in our management certifications filed with this Annual Report on Form 10-K, that our internal control over financialreporting is effective as of June 30, 2008, as our management identified a material weakness in our internal control over financial reporting as it relatesto accounting for revenue transactions. Although we are taking measures to remediate this material weakness as well as other significant deficienciesand control deficiencies, if any, we cannot assure that we will not have additional material weaknesses, significant deficiencies and control deficienciesin the future. This or any future inability to assert that our internal controls over financial reporting are effective for any given reporting period, couldhave an adverse effect on our business and our stock price.We may have difficulties in determining our internal control to be effective due to our complex financial model. The complexity of our financial model contributes to our need for effective financial reporting systems and internal controls. We recognize revenuefrom a range of transactions including CyberKnife system sales, our shared ownership program and services. The CyberKnife system is a complexproduct that contains both hardware and software elements. Since the software component is significant in our solution, we are bound by the softwarerevenue recognition rules for our business. The complexity of the CyberKnife system and of our financial model pertaining to revenue recognitionrequires us to process a broader range of financial transactions than would be required by a company with a less complex financial model. Accordingly,deficiencies or weaknesses in our internal controls would likely impact us more significantly than they would impact a company with a less complexfinancial model.We are required to comply with federal and state "fraud and abuse" law, and, if we are unable to comply with such laws, we could facesubstantial penalties and we could be excluded from government healthcare programs, which would adversely affect our business, financialcondition and results of operations. We are directly or indirectly through our customers, subject to various federal and state laws pertaining to healthcare fraud and abuse. These lawswhich directly or indirectly affect our ability to operate our business primarily include, but are not limited to, the following:•the federal Anti-Kickback Statute, which prohibits persons from knowingly and willfully soliciting, offering, receiving or providingremuneration, directly or indirectly, in cash or in kind, to induce either the referral of an individual, or furnishing or arranging for a goodor service, for which payment may be made under federal healthcare programs such as Medicare and Medicaid; •state law equivalents to the Anti-Kickback Statute, which may not be limited to government reimbursed items; •The Ethics in Patient Referral Act of 1989, also known as the Stark Law, which prohibits subject to certain exceptions, physicianreferrals of Medicare and Medicaid patients to an entity33providing certain "designated health services" if the physician or an immediate family member has any financial relationship with theentity. The Stark Law also prohibits the entity receiving the referral from billing for any good or service furnished pursuant to anunlawful referral; •state law equivalents to the Stark Law, which may provide even broader restrictions and require greater disclosures than the federal law;and •the federal False Claims Act, which prohibits the knowing filing or causing the filing of a false claim or the knowing use of falsestatements to obtain payment from the federal government. The following arrangements with purchasers and their agents have been identified by the Office of the Inspection General of the Department ofHealth and Human Services as ones raising potential risk of violation of the federal Anti-Kickback Statute:•discount and free good arrangements that are not properly disclosed or accurately reported to federal healthcare programs; •product support services, including billing assistance, reimbursement consultation and other services specifically tied to support of thepurchased product, offered in tandem with another service or program (such as reimbursement guarantee) that confers a benefit to thepurchaser; •educational grants conditioned in whole or in part on the purchase of equipment, or otherwise inappropriately influenced by sales andmarketing considerations; •research funding arrangements, particularly post-market research activities, that are linked directly or indirectly to the purchase ofproducts, or otherwise inappropriately influenced by sales and marketing considerations; and •other offers of remuneration to purchasers that is expressly or impliedly related to a sale or sales volume, such as "prebates" and"upfront payment," other free or reduced-price goods or services, and payments to cover costs of "converting" from a competitor'sproducts, particularly where the selection criteria for such offers vary with the volume or value of business generated. We have various arrangements with physicians, hospitals and other entities which implicate these laws. For example, physicians who own ourstock also provide medical advisory and other consulting and personal services. Similarly, we have a variety of different types of arrangements with ourcustomers. For example, our placement and shared ownership program entail the provision of our CyberKnife system to our customers under a deferredpayment program, where we generally receive the greater of a fixed minimum payment or a portion of the revenues of services. Included in the fee wecharge for the placement and shared ownership program are a variety of services, including physician training, educational and marketing support,general reimbursement guidance and technical support, and, in the case of the placement program, certain services and upgrades are provided withoutadditional charge based on procedure volume. In the past, we have also provided loans to our customers. We also provide research grants to customersto support customer studies related to, among other things, our CyberKnife systems. Certain of these arrangements do not meet Anti-Kickback Statutesafe harbor protections, which may result in increased scrutiny by government authorities having responsibility for enforcing these laws. If our past or present operations are found to be in violation of any of the laws described above or other similar governmental regulations to whichwe or our customers are subject, we may be subject to the applicable penalty associated with the violation, including significant civil and criminalpenalties, damages, fines, imprisonment and exclusion from the Medicare and Medicaid programs. The impact of any such violations may lead tocurtailment or restructuring of our operations, which could adversely affect our ability to operate our business and our financial results. The risk of ourbeing found in violation of these laws is increased by the fact that many of these laws are open to a variety of interpretations. Any action against us forviolation of these laws, even if we successfully defend against34it, could cause us to incur significant legal expenses, divert our management's attention from the operation of our business and damage our reputation. Ifenforcement action were to occur, our reputation and our business and financial condition may be harmed, even if we were to prevail or settle the action.Similarly, if the physicians or other providers or entities with which we do business are found to be non-compliant with applicable laws, they may besubject to sanctions, which could also have a negative impact on our business.Modifications, upgrades and future products related to the CyberKnife system or new indications may require new U.S. Food and DrugAdministration, or FDA, premarket approvals or 510(k) clearances, and such modifications, or any defects in design or manufacture may requireus to recall or cease marketing the CyberKnife system until approvals or clearances are obtained. The CyberKnife system is a medical device that is subject to extensive regulation in the United States by local, state and the federal government,including by the FDA. The FDA regulates virtually all aspects of a medical device's design, development, testing manufacturing, labeling, storage,record keeping, reporting, sale, promotion, distribution and shipping. Before a new medical device, or a new use of or claim for an existing product, canbe marketed in the United States, it must first receive either premarket approval or 510(k) clearance from the FDA, unless an exemption exists. Eitherprocess can be expensive and lengthy. The FDA's 510(k) clearance process usually takes from three to twelve months, but it can last longer. Theprocess of obtaining premarket approval is much more costly and uncertain than the 510(k) clearance process and it generally takes from one to threeyears, or even longer, from the time the application is filed with the FDA. Despite the time, effort and cost, there can be no assurance that a particulardevice will be approved or cleared by the FDA through either the premarket approval process or 510(k) clearance process. Medical devices may be marketed only for the indications for which they are approved or cleared. The FDA also may change its policies, adoptadditional regulations, or revise existing regulations, each of which could prevent or delay premarket approval or 510(k) clearance of our device, orcould impact our ability to market our currently cleared device. We are also subject to medical device reporting regulations which require us to report tothe FDA if our products cause or contribute to a death or a serious injury, or malfunction in a way that would likely cause or contribute to a death or aserious injury. We also are subject to Quality System and Medical Device Reporting regulations, which regulate the manufacturing and installation andalso require us to report to the FDA if our products cause or contribute to a death or serious injury, or malfunction in a way that would likely cause orcontribute to a death or serious injury. Our products are also subject to state regulations and various worldwide laws and regulations. A component of our strategy is to continue to upgrade the CyberKnife system. Upgrades previously released by us required 510(k) clearancebefore we were able to offer them for sale. We expect our future upgrades will similarly require 510(k) clearance; however, future upgrades may besubject to the substantially more time consuming and uncertain premarket approval process. The FDA requires device manufacturers to make a determination of whether or not a modification requires an approval or clearance; however, theFDA can review a manufacturer's decision not to submit for additional approvals or clearances. Any modification to an FDA approved or cleared devicethat would significantly affect its safety or efficacy or that would constitute a major change in its intended use would require a new premarket approvalor 510(k) clearance. We cannot assure you that the FDA will agree with our decisions not to seek approvals or clearances for particular devicemodifications or that we will be successful in obtaining 510(k) clearances for modifications. We have obtained 510(k) clearances for the CyberKnife system for the treatment of tumors anywhere in the body where radiation is indicated. Wehave made modifications to the CyberKnife system in the past and may make additional modifications in the future that we believe do not or will35not require additional approvals or clearances. If the FDA disagrees and requires us to obtain additional premarket approvals or 510(k) clearances forany modifications to the CyberKnife system and we fail to obtain such approvals or clearances or fail to secure approvals or clearances in a timelymanner, we may be required to cease manufacturing and marketing the modified device or to recall such modified device until we obtain FDA approvalor clearance and we may be subject to significant regulatory fines or penalties. In addition, even if the CyberKnife system is not modified, the FDA and similar governmental authorities in other countries in which we marketand sell our products have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. Agovernment mandated recall, or a voluntary recall by us, could occur as a result of component failures, manufacturing errors or design defects, includingdefects in labeling and user manuals. Any recall could divert management's attention, cause us to incur significant expenses, harm our reputation withcustomers, negatively affect our future sales and business, require redesign of the CyberKnife system, and harm our operating results. In thesecircumstances, we may also be subject to significant enforcement action. If any of these events were to occur, our ability to introduce new or enhancedproducts in a timely manner would be adversely affected, which in turn would harm our future growth.Our reliance on single source suppliers for critical components of the CyberKnife system could harm our ability to meet demand for our productsin a timely and cost effective manner. We currently depend on single source suppliers for some of the critical components necessary for the assembly of the CyberKnife system,including the robotic manipulator, imaging plates, treatment table, robotic couch and magnetron, which creates the microwaves for use in the linearaccelerator. If any single source suppliers were to cease delivering components to us or fail to provide the components on a timely basis, we might berequired to qualify an alternate supplier and we would likely experience a lengthy delay in our manufacturing processes, which would result in delays ofshipment to end users. We cannot assure you that our single source suppliers will be able or willing to meet our future demands. We generally do not maintain large volumes of inventory. Furthermore, if we are required to change the manufacturer of a critical component of theCyberKnife system, we will be required to verify that the new manufacturer maintains facilities, procedures and operations that comply with our qualityrequirements. We also will be required to assess the new manufacturer's compliance with all applicable regulations and guidelines, which could furtherimpede our ability to manufacture our products in a timely manner. If the change in manufacturer results in a significant change to the product, a new510(k) clearance would be necessary, which would likely cause substantial delays. The disruption or termination of the supply of key components forthe CyberKnife system could harm our ability to generate revenue, lead to customer dissatisfaction and damage our reputation.Our industry is subject to intense competition and rapid technological change, which may result in products or new tumor treatments that aresuperior to the CyberKnife system. If we are unable to anticipate or keep pace with changes in the marketplace and the direction of technologicalinnovation and customer demands, our products may become less useful or obsolete and our operating results will suffer. The medical device industry in general and the non-invasive cancer treatment field in particular are subject to intense and increasing competitionand rapidly evolving technologies. Because our products often have long development and government approval cycles, we must anticipate changes inthe marketplace and the direction of technological innovation and customer demands. To compete successfully, we will need to continue to demonstratethe advantages of our products and technologies over well-established alternative procedures, products and technologies, and convince physicians andother healthcare decision makers of the advantages of our products and technologies. Traditional surgery and other forms of minimally invasiveprocedures, chemotherapy or other drugs remain alternatives to the CyberKnife system. Also, we compete directly with traditional radiosurgery systemsprimarily from Elekta AB (publ), or Elekta, BrainLAB AG, the Integra Radionics business of Integra LifeSciences Holdings Corporation, or Radionics,and Varian Medical Systems, Inc., or Varian.36 The market for standard linear accelerators is dominated by three companies: Elekta, Siemens AG and Varian. In addition, TomoTherapyIncorporated markets and sells a radiation therapy product. The CyberKnife system is not typically used to perform traditional radiation therapy andtherefore does not usually compete directly with standard medical linacs that perform standard radiation therapy. However, some manufacturers ofstandard linac based radiation therapy systems, including Varian and Elekta, have products that can be used in combination with body and/or headframes and image-guidance systems to perform radiosurgery. In addition, many government, academic and business entities are investing substantialresources in research and development of cancer treatments, including surgical approaches, radiation treatment, drug treatment, gene therapy, which isthe treatment of disease by replacing, manipulating, or supplementing nonfunctional genes, and other approaches. Successful developments that result innew approaches for the treatment of cancer could reduce the attractiveness of our products or render them obsolete. Our future success will depend in large part on our ability to establish and maintain a competitive position in current and future technologies. Rapidtechnological development may render the CyberKnife system and its technologies obsolete. Many of our competitors have or may have greatercorporate, financial, operational, sales and marketing resources, and more experience in research and development than we have. We cannot assure youthat our competitors will not succeed in developing or marketing technologies or products that are more effective or commercially attractive than ourproducts or that would render our technologies and products obsolete. We may not have the financial resources, technical expertise, marketing,distribution or support capabilities to compete successfully in the future. Our success will depend in large part on our ability to maintain a competitiveposition with our technologies. Our competitive position also depends on:•widespread awareness, acceptance and adoption by the radiation oncology and cancer therapy markets of our products; •the discovery of new technologies that improve the effectiveness and productivity of the CyberKnife system radiosurgery process; •product coverage and reimbursement from third-party payors, insurance companies and others; •properly identifying customer needs and delivering new products or product enhancements to address those needs; •published studies supporting the efficacy and safety and long-term clinical benefit of the CyberKnife system; •limiting the time required from proof of feasibility to routine production; •limiting the timing and cost of regulatory approvals; •our ability to attract and retain qualified personnel; •the extent of our patent protection or our ability to otherwise develop proprietary products and processes; •securing sufficient capital resources to expand both our continued research and development, and sales and marketing efforts; and •obtaining any necessary United States or foreign marketing approvals or clearances.If the CyberKnife system is not competitive based on these or other factors, our business would be harmed.37We must obtain and maintain regulatory approvals in international markets in which we sell, or seek to sell, our products. In order for us to market and sell the CyberKnife system internationally, either through direct sales personnel or through distributors, we mustobtain and maintain regulatory clearances applicable to the countries and regions in which we are selling, or are seeking to sell, our products. Theseregulatory approvals and clearances, and the process required to obtain and maintain them, vary substantially among international jurisdictions. In somejurisdictions, we rely on our distributors to manage the regulatory process and we are dependent on their ability to do so effectively. For example, ourregulatory approval in Japan was suspended for a period of twelve months during 2003 as a result of a failure of our former distributor to coordinateproduct modifications and obtain necessary regulatory clearances in a timely manner. As a result, the CyberKnife system was recalled in Japan and ourformer Japanese distributor was told to stop selling the CyberKnife system. In response, we retained a regulatory consultant who was not affiliated withour former Japanese distributor and worked with the Japanese Ministry of Health, Labor and Welfare and applied for, and received, approval to sell anupdated version of the CyberKnife system under the name of CyberKnife II in Japan. By working with a new distributor, Chiyoda TechnolCorporation, we were able to begin distributing the CyberKnife II system in 2004 with no probationary period. In China, the CyberKnife system isbeing assessed by the Ministry of Health, which regulates the operation of certain types of medical capital equipment products and systems by hospitalsin the public civilian health care system. Until this review is complete, our ability to sell systems to public civilian hospitals in China will be constrained.In the event that we are unable to obtain and maintain regulatory clearances for the CyberKnife system, including new clearances for system upgradesand use of the system anywhere in the body, in international markets we have entered or desire to enter, our international sales could fail to grow ordecline.It is difficult and costly to protect our intellectual property and our proprietary technologies, and we may not be able to ensure their protection. Our success depends significantly on our ability to obtain, maintain and protect our proprietary rights to the technologies used in our products.Patents and other proprietary rights provide uncertain protections, and we may be unable to protect our intellectual property. For example, we may beunsuccessful in defending our patents and other proprietary rights against third party challenges. In addition to patents, we rely on a combination of trade secrets, copyright and trademark laws, nondisclosure agreements and other contractualprovisions and technical security measures to protect our intellectual property rights. These measures may not be adequate to safeguard the technologyunderlying our products. If they do not protect our rights adequately, third parties could use our technology, and our ability to compete in the marketwould be reduced. Although we have attempted to obtain patent coverage for our technology where available and appropriate, there are aspects of thetechnology for which patent coverage was never sought or never received. There are also countries in which we sell or intend to sell the CyberKnifesystem but have no patents or pending patent applications. Our ability to prevent others from making or selling duplicate or similar technologies will beimpaired in those countries in which we have no patent protection. Although we have several issued patents in the United States and in foreign countriesprotecting aspects of the CyberKnife system, our pending United States and foreign patent applications may not issue, may issue only with limitedcoverage or may issue and be subsequently successfully challenged by others and held invalid or unenforceable. Similarly, our issued patents and those of our licensors may not provide us with any competitive advantages. Competitors may be able to designaround our patents or develop products which provide outcomes comparable or superior to ours. Our patents may be held invalid or unenforceable as aresult of legal challenges by third parties, and others may challenge the inventorship or ownership of our38patents and pending patent applications. In addition, the laws of some foreign countries may not protect our intellectual property rights to the sameextent as do the laws of the United States. In the event a competitor infringes upon our patent or other intellectual property rights, enforcing those rightsmay be difficult and time consuming. Even if successful, litigation to enforce our intellectual property rights or to defend our patents against challengecould be expensive and time consuming and could divert our management's attention. We may not have sufficient resources to enforce our intellectualproperty rights or to defend our patents against a challenge. We also license patent and other proprietary rights to aspects of our technology to third parties in fields where we currently do not operate as wellas in fields where we currently do operate. Disputes with our licensees may arise regarding the scope and content of these licenses. Further, our abilityto expand into additional fields with our technologies may be restricted by our existing licenses or licenses we may grant to third parties in the future. In October 2006, January 2007 and February 2007, we received correspondence from American Science and Engineering, Inc., or AS&E,expressing concerns that we may be using certain intellectual property we acquired from AS&E through the HES acquisition in a manner that breaches,or may breach, our contractual obligations under a license agreement with them in certain non-medical fields. As of June 30, 2008, we have not receivedany further correspondence from AS&E regarding this issue. The intellectual property at issue relates to the development of a next-generation linac thatcould be used for medical as well as non-medical purposes. We are developing the technology used in the next-generation linac independently from theintellectual property we obtained from the HES acquisition. While we do not believe our activities breach or violate the terms of the license agreement,we cannot assure you that AS&E will not commence litigation on the grounds that we are in breach of our obligations under the license agreement. The policies we use to protect our trade secrets may not be effective in preventing misappropriation of our trade secrets by others. In addition,confidentiality agreements executed by our employees, consultants and advisors may not be enforceable or may not provide meaningful protection forour trade secrets or other proprietary information in the event of unauthorized use or disclosure. Litigating a trade secret claim is expensive and timeconsuming, and the outcome is unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets. Moreover,our competitors may independently develop equivalent knowledge methods and know-how. If we are unable to protect our intellectual property rights,we may be unable to prevent competitors from using our own inventions and intellectual property to compete against us, and our business may beharmed.Because the medical device industry is characterized by competing intellectual property, we may be sued for violating the intellectual property rightsof others. The medical device industry is characterized by a substantial amount of litigation over patent and other intellectual property rights. In particular, thefield of radiation treatment of cancer is well established and crowded with the intellectual property of competitors and others. A number of companies inour market, as well as universities and research institutions, have issued patents and have filed patent applications which relate to the use of stereotacticradiosurgery to treat solid cancerous and benign tumors. Determining whether a product infringes a patent involves complex legal and factual issues, and the outcome of patent litigation actions is oftenuncertain. We have not conducted an extensive search of patents issued to third parties, and no assurance can be given that third party patents containingclaims covering our products, parts of our products, technology or methods do not exist, have not been filed, or could not be filed or issued. Because ofthe number of patents issued and patent applications filed in our technical areas or fields, our competitors or other third parties may assert that ourproducts and the methods we employ in the use of our products are covered by United States or foreign patents39held by them. In addition, because patent applications can take many years to issue and because publication schedules for pending applications vary byjurisdiction, there may be applications now pending of which we are unaware, and which may result in issued patents which our current or futureproducts infringe. Also, because the claims of published patent applications can change between publication and patent grant, there may be publishedpatent applications that may ultimately issue with claims that we infringe. There could also be existing patents that one or more of our products or partsmay infringe and of which we are unaware. As the number of competitors in the market for less invasive cancer treatment alternatives grows, and as thenumber of patents issued in this area grows, the possibility of patent infringement claims against us increases. Some of our competitors may be able tosustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, anyuncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise the funds necessaryto continue our operations. In the event that we become subject to a patent infringement or other intellectual property lawsuit and if the relevant patents or other intellectualproperty were upheld as valid and enforceable and we were found to infringe or violate the terms of a license to which we are a party, we could beprevented from selling our products unless we could obtain a license or were able to redesign the product to avoid infringement. If we were unable toobtain a license or successfully redesign our system, we might be prevented from selling our system. If there is an allegation or determination that wehave infringed the intellectual property rights of a competitor or other person, we may be required to pay damages, or a settlement or ongoing royalties.In these circumstances, we may be unable to sell our products at competitive prices or at all, our business and operating results could be harmed.We could become subject to product liability claims, product recalls, other field actions and warranty claims that could be expensive, divertmanagement's attention and harm our business. Our business exposes us to potential liability risks that are inherent in the manufacturing, marketing and sale of medical device products. We maybe held liable if the CyberKnife system causes injury or death or is found otherwise unsuitable during usage. Our products incorporate sophisticatedcomponents and computer software. Complex software can contain errors, particularly when first introduced. In addition, new products orenhancements may contain undetected errors or performance problems that, despite testing, are discovered only after installation. Because our productsare designed to be used to perform complex surgical procedures, defects could result in a number of complications, some of which could be serious andcould harm or kill patients. It is also possible that defects in the design, manufacture or labeling of our products might necessitate a product recall orother field corrective action, which may result in warranty claims beyond our expectations and may harm our reputation. A product liability claim,regardless of its merit or eventual outcome, could result in significant legal defense costs. The coverage limits of our insurance policies may not beadequate to cover future claims. If sales of our products increase or we suffer future product liability claims, we may be unable to maintain productliability insurance in the future at satisfactory rates or with adequate amounts. A product liability claim, any product recalls or other field actions orexcessive warranty claims, whether arising from defects in design or manufacture or otherwise, could negatively affect our sales or require a change inthe design, manufacturing process or the indications for which the CyberKnife system may be used, any of which could harm our reputation andbusiness, result in a decline in revenue. In addition, if a product we designed or manufactured is defective, whether due to design or manufacturing defects, improper use of the product orother reasons, we may be required to notify regulatory authorities and/or to recall the product, possibly at our expense. We have voluntarily conductedrecalls and product corrections in the past. In 2002, we were subject to a product recall in Japan, as a result of a failure of our prior distributor tocoordinate product modifications and obtain40necessary regulatory approvals in a timely manner. In April 2007, we initiated a product correction at twenty different sites related to a softwaremalfunction of the CyberKnife system. As a result of this software malfunction, we provided affected devices with software upgrades designed tocorrect the problems that have been identified. We have notified the FDA regarding these software upgrades and corrections. We cannot ensure that theFDA will not require that we take additional actions to address the software malfunctions. A required notification to a regulatory authority or recallcould result in an investigation by regulatory authorities of our products, which could in turn result in required recalls, restrictions on the sale of theproducts or other civil or criminal penalties. The adverse publicity resulting from any of these actions could cause customers to review and potentiallyterminate their relationships with us. These investigations or recalls, especially if accompanied by unfavorable publicity or termination of customercontracts, could result in our incurring substantial costs, losing revenues and damaging our reputation, each of which would harm our business.The safety and efficacy of our products for certain uses is not yet supported by long-term clinical data and may therefore prove to be less safe andeffective than initially thought. Although we believe that the CyberKnife system has advantages over competing products and technologies, we do not have sufficient clinical datademonstrating these advantages for all tumor indications. For example, because our CyberKnife procedures are relatively new, we have limited clinicaldata relating to the effectiveness of the CyberKnife system as a means of controlling the growth of cancer at a particular body site. In addition, we haveonly limited five-year patient survival rate data, which is a common long-term measure of clinical effectiveness in cancer treatment. Further, futurepatient studies or clinical experience may indicate that treatment with the CyberKnife system does not improve patient outcomes. Such results couldslow the adoption of our products by physicians, significantly reduce our ability to achieve expected revenues and could prevent us from becomingprofitable. In addition, if future results and experience indicate that our products cause unexpected or serious complications or other unforeseen negativeeffects, the FDA could rescind our clearances, our reputation with physicians, patients and others may suffer and we could be subject to significant legalliability.The CyberKnife system has been in use for a limited period of time for uses outside the brain and the medical community has not yet developed alarge quantity of peer-reviewed literature that supports safe and effective use in those locations in the body. The CyberKnife system was initially cleared by a number of regulatory authorities for the treatment of tumors in the brain and neck. More recently,the CyberKnife system has been cleared in the United States to treat tumors anywhere in the body where radiation is indicated, and our future growth isdependent in large part on continued growth in full body use of the system. Currently, however, there are a limited number of peer-reviewed medicaljournal publications regarding the safety and efficacy of the CyberKnife system for treatment of tumors outside the brain or spine. If later studies showthat the CyberKnife system is less effective or less safe with respect to particular types of solid tumors, or in the event clinical studies do not achieve theresults anticipated at the outset of the study, use of the CyberKnife system could fail to increase or could decrease and our growth and operating resultswould therefore be harmed.International sales of the CyberKnife system account for a significant portion of our revenue, which exposes us to risks inherent in internationaloperations. Our international sales for the fiscal year ended June 30, 2008 increased as compared to our fiscal year ended June 30, 2007. We anticipate that asignificant portion of our revenue will continue to be41derived from sales of the CyberKnife system in foreign markets. This revenue and related operations will therefore continue to be subject to the risksassociated with international operations, including:•economic or political instability; •shipping delays; •changes in foreign regulatory laws governing sales of medical devices; •difficulties in enforcing agreements with and collecting receivables from customers outside the United States; •longer payment cycles associated with many customers outside the United States; •adequate reimbursement for the CyberKnife procedure outside the United States; •failure of local laws to provide the same degree of protection against infringement of our intellectual property; •protectionist laws and business practices that favor local competitors; and •contractual provisions governed by foreign laws and various trade restrictions, including U.S. prohibitions and restrictions on exports ofcertain products and technologies to certain nations. Our international operations are also subject to United States laws regarding the conduct of business overseas by U.S. companies. In particular, theU.S. Foreign Corrupt Practices Act, or FCPA, prohibits the provision of illegal or improper inducements to foreign government officials in connectionwith the obtaining of business overseas. Violations of the FCPA by us or any of our employees or executive officers could subject us or the individualsinvolved to criminal or civil liability and could therefore materially harm our business. In addition, future imposition of, or significant increases in, the level of customs duties, export quotas, regulatory restrictions or trade restrictionscould materially harm our business. Currently, the majority of our international sales are denominated in U.S. dollars. As a result, an increase in thevalue of the U.S. dollar relative to foreign currencies could require us to reduce our sales price or make our products less competitive in internationalmarkets. If we are unable to address these risks and challenges effectively, our international operations may not be successful and our business wouldbe materially harmed.We depend on third-party distributors to market and distribute the CyberKnife system in international markets. If our distributors fail tosuccessfully market and distribute the CyberKnife system, our business will be materially harmed. We depend on a limited number of distributors in our international markets. These international distribution relationships are exclusive bygeographic region. We cannot control the efforts and resources our third-party distributors will devote to marketing the CyberKnife system. Ourdistributors may not be able to successfully market and sell the CyberKnife system, may not devote sufficient time and resources to support themarketing and selling efforts and may not market the CyberKnife system at prices that will permit the product to develop, achieve or sustain marketacceptance. If we or our distributors terminate our existing agreements, finding new distributors could be an expensive and time-consuming process andsales could decrease during and after any transition period. If we are unable to attract additional international distributors, our international revenue maynot grow. If our distributors experience difficulties, do not actively market the CyberKnife system or do not otherwise perform under our distributionagreements, our potential for revenue from international markets may be dramatically reduced, and our business could be harmed. In certain cases ourdistributors are responsible for the service and support of our CyberKnife systems.42We have limited experience and capability in manufacturing and may encounter manufacturing problems or delays that could result in lostrevenue. The CyberKnife system is complex, and requires the integration of a number of components from several sources of supply. We must manufactureand assemble these complex systems in commercial quantities in compliance with regulatory requirements and at an acceptable cost. We have a limitedhistory of manufacturing commercial quantities of the CyberKnife system. In particular, we have recently begun manufacturing compact linacs as acomponent of the CyberKnife system. Our linac components are extremely complex devices and require significant expertise to manufacture, and as aresult of our limited manufacturing experience we may have difficulty producing needed materials in a commercially viable manner. We may encounterdifficulties in scaling up production of the CyberKnife system, including problems with quality control and assurance, component supply shortages,increased costs, shortages of qualified personnel and/or difficulties associated with compliance with local, state, federal and foreign regulatoryrequirements. If our manufacturing capacity does not keep pace with product demand, we will not be able to fulfill orders in a timely manner which inturn may have a negative effect on our financial results and overall business. Conversely, if demand for our products decreases, the fixed costsassociated with excess manufacturing capacity may adversely affect our financial results. Our manufacturing processes and the manufacturing processes of our third-party suppliers are required to comply with the FDA's Quality SystemRegulation, or QSR. The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, production processes,controls, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products. We are also subject to state requirements andlicenses applicable to manufacturers of medical devices. Because our manufacturing processes include diagnostic and therapeutic X-ray equipment andlaser equipment, we are subject to the electronic product radiation control provisions of the Federal Food, Drug and Cosmetic Act, which requires thatwe file reports with the FDA, applicable states and our customers regarding the distribution, manufacturing and installation of these types of equipment.The FDA enforces the QSR and the electronic product radiation control provisions through periodic unannounced inspections. We have been, andanticipate in the future to be, subject to such inspections. Our failure or the failure of a third-party supplier to pass a QSR inspection or to comply withthese and other applicable regulatory requirements could result in disruption of our operations and manufacturing delays. Our failure to take prompt andsatisfactory corrective action in response to an adverse inspection or our failure to comply with applicable standards could result in enforcement actions,including a public warning letter, a shutdown of our manufacturing operations, a recall of our products, civil or criminal penalties, or other sanctions,which would cause our sales and business to suffer. We cannot assure you that the FDA or other governmental authorities would agree with ourinterpretation of applicable regulatory requirements or that we or our third-party suppliers have in all instances fully complied with all applicablerequirements. If we cannot achieve the required level and quality of production, we may need to outsource production or rely on licensing and other arrangementswith third parties who possess sufficient manufacturing facilities and capabilities in compliance with regulatory requirements. Even if we couldoutsource needed production or enter into licensing or other third party arrangements, this could reduce our gross margin and expose us to the risksinherent in relying on others. We also cannot assure you that our suppliers will deliver an adequate supply of required components on a timely basis orthat they will adequately comply with the QSR. Failure to obtain these components on a timely basis would disrupt our manufacturing processes andincrease our costs, which would harm our operating results.43We depend on key employees, the loss of whom would adversely affect our business. If we fail to attract and retain employees with the expertiserequired for our business, we may be unable to continue to grow our business. We are highly dependent on the members of our senior management, operations and research and development staff. Our future success willdepend in part on our ability to retain these key employees and to identify, hire and retain additional personnel. Competition for qualified personnel inthe medical device industry, particularly in northern California, is intense, and finding and retaining qualified personnel with experience in our industryis very difficult. We believe there are only a limited number of individuals with the requisite skills to serve in many of our key positions and we competefor key personnel with other medical equipment and software manufacturers and technology companies, as well as universities and research institutions.It is increasingly difficult to hire and retain these persons, and we may be unable to replace key persons if they leave or fill new positions requiring keypersons with appropriate experience. A significant portion of our compensation to our key employees is in the form of stock option grants. A prolongeddepression in our stock price could make it difficult for us to retain our employees and recruit additional qualified personnel. We do not maintain, and donot currently intend to obtain, key employee life insurance on any of our personnel. If we fail to hire and retain personnel in key positions, we may beunable to continue to grow our business successfully.If we do not effectively manage our growth, our business may be significantly harmed. The number of our employees increased from 194 as of June 30, 2005 to 504 as of June 30, 2008. In order to implement our business strategy, weexpect continued growth in our employee and infrastructure requirements, particularly as we expand our manufacturing and sales and marketingcapacities. To manage our growth, we must expand our facilities, augment our management, operational and financial systems, hire and train additionalqualified personnel, scale-up our manufacturing capacity and expand our marketing and distribution capabilities. Our manufacturing, assembly andinstallation process is complex and occurs over many months, and we must effectively scale this entire process to satisfy customer expectations andchanges in demand. We also expect to increase the number of sales and marketing personnel as we expand our business. Further, to accommodate ourgrowth and compete effectively, we will be required to improve our information systems. We cannot be certain that our personnel, systems, proceduresand internal controls will be adequate to support our future operations. If we cannot manage our growth effectively, our business will suffer.Any failure in our physician training efforts could result in lower than expected product sales and potential liabilities. A critical component of our sales and marketing efforts is the training of a sufficient number of physicians to properly utilize the CyberKnifesystem. We rely on physicians to devote adequate time to learn to use our products. If physicians are not properly trained, they may misuse orineffectively use our products. This may result in unsatisfactory patient outcomes, patient injury and related liability or negative publicity which couldhave an adverse effect on our product sales.As a result of being a public company, we are incurring increased costs. As we have recently completed our first full fiscal year as a public company, we have incurred and will continue to incur increased legal,accounting and other expenses that we did not incur as a private company as we are now subject to Securities and Exchange Commission, or SEC,NASDAQ Stock Market and other rules focusing on corporate governance and financial reporting. In particular, we were first required to comply withSection 404 of the Sarbanes-Oxley Act regarding management assessment of internal controls during our 2008 fiscal year and we will be required to doso in future years. As a result, we expect to continue to incur substantial fees and costs for future audits. We also44expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance and we may berequired to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may bemore difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. We continue to monitordevelopments with respect to these requirements, but we cannot predict or estimate the amount of additional costs we may incur or the timing of suchcosts.Our ability to raise capital in the future may be limited, and our failure to raise capital when needed could prevent us from executing our growthstrategy. While we believe that our existing cash and short-term and long-term investments will be sufficient to meet our anticipated cash needs for at leastthe next 12 months, the timing and amount of our working capital and capital expenditure requirements may vary significantly depending on numerousfactors, including:•market acceptance of our products; •the need to adapt to changing technologies and technical requirements; •the existence of opportunities for expansion; and •access to and availability of sufficient management, technical, marketing and financial personnel. If our capital resources are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity securities or debt securities orobtain other debt financing. The sale of additional equity securities or convertible debt securities would result in additional dilution to our stockholders.Additional debt would result in increased expenses and could result in covenants that would restrict our operations. We have not made arrangements toobtain additional financing, and we cannot assure you that financing, if required, will be available in amounts or on terms acceptable to use, if at all.We may attempt to acquire new businesses, products or technologies, and if we are unable to successfully complete these acquisitions or tointegrate acquired businesses, products, technologies or employees, we may fail to realize expected benefits or harm our existing business. Our success will depend, in part, on our ability to expand our product offerings and grow our business in response to changing technologies,customer demands and competitive pressures. In some circumstances, we may determine to do so through the acquisition of complementary businesses,products or technologies rather than through internal development. The identification of suitable acquisition candidates can be difficult, time consumingand costly, and we may not be able to successfully complete identified acquisitions. Furthermore, even if we successfully complete an acquisition, wemay not be able to successfully integrate newly acquired organizations, products or technologies into our operations, and the process of integrationcould be expensive, time consuming and may strain our resources. In addition, we may be unable to retain employees of acquired companies, or retainthe acquired company's customers, suppliers, distributors or other partners who are our competitors or who have close relationships with ourcompetitors. Consequently, we may not achieve anticipated benefits of the acquisitions which could harm our existing business. In addition, futureacquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or expenses, or other chargessuch as in-process research and development, any of which could harm our business and affect our financial results or cause a reduction in the price ofour common stock.45Our operations are vulnerable to interruption or loss due to natural disasters, epidemics, terrorist acts and other events beyond our control,which would adversely affect our business. Our manufacturing facility is located in a single location in Sunnyvale, California. We do not maintain a backup manufacturing facility, so wedepend on our current facility for the continued operation of our business. In addition, we conduct a significant portion of other activities includingadministration and data processing at facilities located in the State of California which has experienced major earthquakes in the past, as well as othernatural disasters. We carry limited earthquake insurance for inventory only. Such coverage may not be adequate or continue to be available atcommercially reasonable rates and terms. In the event of a major earthquake or other disaster affecting our facilities, it could significantly disrupt ouroperations, delay or prevent product manufacture and shipment for the time required to repair, rebuild or replace our manufacturing facilities, whichcould be lengthy, and result in large expenses to repair or replace the facilities. In addition, concerns about terrorism or an outbreak of epidemic diseasessuch as avian influenza or severe acute respiratory syndrome, or SARS, especially in our major markets of North America, Europe and Asia could havea negative effect on travel and our business operations, and result in adverse consequences on our revenues and financial performance.Risks Related to Our Common StockThe price of our common stock is volatile and may continue to fluctuate significantly, which could lead to losses for stockholders. The trading prices of the stock of newly public companies can experience extreme price and volume fluctuations. These fluctuations often havebeen unrelated or out of proportion to the operating performance of these companies. Since we became a public company in February 2007, our stockprice has been similarly volatile. These broad market fluctuations may continue and could harm our stock price. Any negative change in the public'sperception of the prospects of companies that employ similar technology or sell into similar markets could also depress our stock price, regardless ofour actual results. Factors affecting the trading price of our common stock include:•regulatory developments related to manufacturing the CyberKnife system; •variations in our operating results; •changes in our operating results as a result of problems with our internal controls; •announcements of technological innovations, new services or service enhancements, strategic alliances or significant agreements by us orby our competitors; •recruitment or departure of key personnel; •changes in the estimates of our operating results or changes in recommendations by any securities analyst that elects to follow ourcommon stock; •market conditions in our industry, the industries of our customers and the economy as a whole; •sales of large blocks of our common stock; and •changes in accounting principles or changes in interpretations of existing principles, which could affect our financial results.46Substantial sales of our common stock by our stockholder, including sales pursuant to 10b5-1 plans, could depress our stock price regardless ofour operating results. Sales of substantial amounts of our common stock in the public market could reduce the prevailing market prices for our common stock. As ofAugust 29, 2008, we have 54,629,296 shares of common stock outstanding. The lockup agreements related to our initial public offering expired withthe opening of the securities markets on September 4, 2007, and as a result a large number of shares of our common stock became eligible for sale. In addition, certain of our executive officers, including our Chief Executive Officer, Chief Financial Officer, Chief Marketing Officer, ChiefOperating Officer and Chief Sales Officer, have entered into sales plans pursuant to Securities and Exchange Commission rule 10b5-1, which providesfor stock sales pursuant to formulas set forth in each such plan. Other executive officers or directors of ours and other members of our managementteam who are not executive officers may in the future enter into such plans. If our existing stockholders sell a large number of shares of our common stock or the public market perceives that existing stockholders might sellshares of common stock, including sales pursuant to 10b5-1 plans, the market price of our common stock could decline significantly. These sales mightalso make it more difficult for us to sell equity securities at a time and price that we deem appropriate.Our directors, executive officers and major stockholders own approximately 32.3% of our outstanding common stock as of August 29, 2008,which could limit your ability to influence the outcome of key transactions, including changes of control. As of August 29, 2008, our directors, executive officers, and current holders of 5% or more of our outstanding common stock, held, in theaggregate, approximately 32.3% of our outstanding common stock. As a result, a small number of stockholders have voting control and may be able tocontrol the election of directors and the approval of significant corporate transactions. This concentration of ownership may also delay, deter or preventa change of control of our company and will make some transactions more difficult or impossible without the support of these stockholders.We have implemented anti-takeover provisions that could discourage or prevent a takeover, even if an acquisition would be beneficial in theopinion of our stockholders. Provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so would bebeneficial in the opinion of our stockholders. These provisions include:•authorizing the issuance of "blank check" preferred stock that could be issued by our board of directors to increase the number ofoutstanding shares and thwart a takeover attempt; •establishing a classified board of directors, which could discourage a takeover attempt; •prohibiting cumulative voting in the election of directors, which would limit the ability of less than a majority of stockholders to electdirector candidates; •limiting the ability of stockholders to call special meetings of stockholders; •prohibiting stockholder action by written consent and requiring that all stockholder actions be taken at a meeting of our stockholders; and•establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be actedupon by stockholders at stockholder meetings. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change of control of our company.Generally, Section 203 prohibits stockholders who, alone47or together with their affiliates and associates, own more than 15% of the subject company from engaging in certain business combinations for a periodof three years following the date that the stockholder became an interested stockholder of such subject company without approval of the board or662/3% of the independent stockholders. The existence of these provisions could adversely affect the voting power of holders of common stock andlimit the price that investors might be willing to pay in the future for shares of our common stock.We have not paid dividends in the past and do not expect to pay dividends in the future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain all future earnings for the operation andexpansion of our business and, therefore, do not anticipate declaring or paying cash dividends in the foreseeable future. The payment of dividends willbe at the discretion of our board of directors and will depend on our results of operations, capital requirements, financial condition, prospects,contractual arrangements, and other factors our board of directors may deem relevant. If we do not pay dividends, a return on a stockholders' investmentwill only occur if our stock price appreciates.Item 1B. UNRESOLVED STAFF COMMENTS None.Item 2. PROPERTIES Facilities We lease approximately 176,000 square feet of product development, manufacturing and administrative space in three buildings in Sunnyvale,California, and approximately 25,000 square feet of development and manufacturing space in Mountain View, California. Our headquarters building,which is approximately 73,000 square feet, is leased to us until December 2009 and an additional office building, which is approximately 53,000 squarefeet, is leased to us until May 2010. Our manufacturing facility in Sunnyvale is approximately 50,000 square feet and is leased to us until December2011. The Mountain View facility is leased to us until September 2010. We have the right to renew the term of our headquarters lease for one three-yearterm upon prior written notice and the fulfillment of certain conditions. We also maintain offices in Pittsburgh, Pennsylvania, France, China, Japan,Spain, and India. We believe our current facilities are adequate to meet our current needs, but additional space, including additional radiation-shieldedareas in which systems can be assembled and tested, will be required in the future to accommodate anticipated increases in manufacturing needs.Item 3. LEGAL PROCEEDINGS From time to time we are involved in legal proceedings arising in the ordinary course of our business. We believe that there is no litigation pendingthat could have a material adverse effect on our results of operations and financial condition.Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None.48PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF EQUITY SECURITIES Stock Information Our common stock is traded on the Nasdaq Global Market under the symbol "ARAY." The high and low sale prices for each quarterly periodduring our fiscal years ended June 30, 2008 and June 30, 2007 are as follows: High Low Year ended June 30, 2008 First Quarter $22.92 $12.50 Second Quarter $20.99 $14.12 Third Quarter $18.20 $7.82 Fourth Quarter $10.19 $6.86 Year ended June 30, 2007 First Quarter N/A N/A Second Quarter N/A N/A Third Quarter (beginning February 8, 2007) $31.09 $19.66 Fourth Quarter $27.58 $21.50 We have never paid cash dividends on our common stock. Our Board of Directors intends to use any future earnings to support operations andreinvest in the growth and development of our business. There are no current plans to pay out cash dividends to common stockholders in theforeseeable future. As of August 29, 2008, there were 114 registered stockholders of record of our common stock.49Stock Performance Graph The graph set forth below compares the cumulative total stockholder return on our common stock between February 8, 2007 (the date of our initialpublic offering) and June 30, 2008, with the cumulative total return of (i) the S&P Healthcare Index and (ii) the Nasdaq Composite Index, over the sameperiod. This graph assumes the investment of $100.00 on February 8, 2007 in our common stock, the S&P Healthcare Index and the NasdaqComposite Index, and assumes the reinvestment of dividends, if any. The graph assumes the initial value of our common stock on February 8, 2007was the closing sales price of $28.47 per share. The comparisons shown in the graph below are based upon historical data. We caution that the stock price performance shown in the graph belowis not necessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock. Information used in the graph wasobtained from Research Data Group, a source believed to be reliable, but we are not responsible for any errors or omissions in such information.COMPARISON OF 17 MONTH CUMULATIVE TOTAL RETURN*Among Accuray Incorporated, The NASDAQ Composite IndexAnd The S&P Healthcare Index *$100 invested on February 8, 2007 in stock or on January 31, 2007 in index-including reinvestment of dividends.50Securities authorized for issuance under equity compensation plans The following table sets forth as of June 30, 2008 certain information regarding our equity compensation plans. All of our equity compensationplans have been approved by our security holders. A B C Plan category Number ofsecuritiesto be issuedupon exercise ofoutstandingoptions,warrants, andrights Weighted-averageexercise price ofoutstandingoptions,warrants, andrights Number of securitiesremaining availableforfuture issuance underequity compensationplans(excluding securitiesreflectedin Column A)(1) Equity compensation plans approved by security holders 9,212,831 $5.70 2,226,181 Equity compensation plans not approved by security holders — — — Total 9,212,831 $5.70 2,226,181 (1)Includes securities to be issued upon vesting of 724,034 restricted stock units at a weighted average grant date fair value of $23.43.Issuer Purchases of Equity Securities TotalNumberof SharesPurchased Average PricePaid per Share Total Number ofSharesPurchased asPart of PubliclyAnnouncedProgram Approximate DollarValue of Shares thatMay be Purchasedunder the Program March 30–April 26, 2008 — $— — $3.4 million April 27–May 24, 2008 — $— — $3.4 million May 25–June 28, 2008 260,000 $9.03 260,000 $1.0 million Total 260,000 $9.03 260,000 $1.0 million On August 30, 2007 we announced that our Board of Directors had approved a stock repurchase plan that authorized us to repurchase shares ofour common stock. Under the plan, we will have the ability to acquire up to $25.0 million of common shares in the open market over a period of oneyear. During the period from July 1, 2007 through June 30, 2008, we repurchased 2,140,018 shares of our common stock for approximately$24.0 million or an average repurchase price of $11.21 per share. Such shares have not been retired and therefore remain issued as of June 30, 2008.We account for our treasury stock under the par value method. At June 30, 2008, the par value of our treasury stock was immaterial.51Item 6. SELECTED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with, and are qualified by reference to, our consolidated financialstatements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere inthis Form 10-K. The consolidated statements of operations for the years ended June 30, 2008, 2007 and 2006, and the consolidated balance sheet data atJune 30, 2008 and 2007, are derived from, and are qualified by reference to, the consolidated financial statements that have been audited by ourindependent registered public accounting firm, which are included elsewhere in this Form 10-K. The consolidated statements of operations data for theyears ended June 30, 2005 and 2004 and the consolidated balance sheet data at June 30, 2006, 2005 and 2004 are derived from our audited consolidatedfinancial statements not included in this Form 10-K. The unaudited consolidated financial statements include, in the opinion of management, alladjustments, which include only normal recurring adjustments, necessary for the fair presentation of the financial data set forth in those statements. Thehistorical results presented below are not necessarily indicative of future results. Years ended June 30, 2008 2007 2006 2005 2004 (in thousands, except per share data) Consolidated Statements of OperationsData: Net revenue $210,381 $140,452 $52,897 $22,377 $19,569 Cost of revenue(1) 103,429 60,413 27,492 11,115 8,496 Gross profit 106,952 80,039 25,405 11,262 11,073 Operating expenses: Selling and marketing(1) 42,726 37,889 25,186 16,361 10,647 Research and development(1) 32,880 26,775 17,788 11,655 7,311 General and administrative(1) 32,280 23,915 15,923 8,129 4,672 Total operating expenses 107,886 88,579 58,897 36,145 22,630 Loss from operations (934) (8,540) (33,492) (24,883) (11,557)Interest and other income (expense), net 7,184 3,530 56 (238) (136) Income (loss) before provision for incometaxes and cumulative effect of change inaccounting principle 6,250 (5,010) (33,436) (25,121) (11,693)Provision for income taxes 867 1,444 258 68 3 Income (loss) before cumulative effect ofchange in accounting principle 5,383 (6,454) (33,694) (25,189) (11,696)Cumulative effect of change in accountingprinciple, net of tax of $0 — 838 — — — Net income (loss) attributable to commonstockholders $5,383 $(5,616)$(33,694)$(25,189)$(11,696) Net income (loss) per common share: Basic Income (loss) before cumulative effectof change in accounting principle $0.10 $(0.21)$(2.11)$(1.76)$(1.00) Cumulative effect of change inaccounting principle — 0.03 — — — Basic net income (loss) per share $0.10 $(0.18)$(2.11)$(1.76)$(1.00) Diluted Income (loss) before cumulative effectof change in accounting principle $0.09 $(0.21)$(2.11)$(1.76)$(1.00) Cumulative effect of change inaccounting principle — 0.03 — — — Diluted net income (loss) per share $0.09 $(0.18)$(2.11)$(1.76)$(1.00) Weighted average common sharesoutstanding used in computing netincome (loss) per share:  Basic 54,531 30,764 15,997 14,283 11,737 Diluted 60,434 30,764 15,997 14,283 11,737 52(1)Includes stock-based compensation expense as follows: Years ended June 30, 2008 2007 2006 2005 2004 (in thousands) Cost of revenue $1,858 $1,205 $863 $454 $190 Selling and marketing $4,197 $3,958 $2,569 $1,903 $826 Research and development $3,059 $2,448 $1,574 $1,157 $648 General and administrative $7,785 $5,016 $3,237 $2,812 $785 Years endedJune 30, 2008 2007 2006 Selected Operating Data: Number of CyberKnife systems installed per year United States (including Puerto Rico) 19 22 22 International 12 11 6 Total 31 33 28 As of June 30, 2008 2007 2006 2005 2004 (in thousands) Consolidated Balance Sheet Data: Cash and cash equivalents $36,936 $204,830 $27,856 $17,024 $9,722 Short-term investments $85,536 $— $— $— $— Long-term investments $37,014 $— $— $— $— Deferred cost of revenue $43,391 $61,231 $56,588 $36,476 $22,443 Total assets $295,004 $332,109 $138,623 $86,860 $52,443 Short-term debt $— $— $— $2,893 $817 Deferred revenue $114,175 $154,257 $149,664 $89,975 $47,953 Working capital (deficit) $87,744 $148,522 $(3,783)$2,181 $(163) Redeemable convertible preferred stock $— $— $27,504 $27,504 $27,504 Stockholders' equity (deficiency) $130,763 $125,443 $(80,855)$(56,172)$(38,861)53Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion of our consolidated financial condition and results of operations in conjunction with the financialstatements and the notes thereto included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans,estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause orcontribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Risk Factors."Overview We have developed the first and only commercially available intelligent robotic radiosurgery system, the CyberKnife system, designed to treat solidtumors anywhere in the body as an alternative to traditional surgery. The CyberKnife system combines continuous image-guidance technology with acompact linear accelerator that has the ability to move in three dimensions according to the treatment plan. Our image-guidance technology continuouslyacquires images to track a tumor's location and transmits any position corrections to the robotic arm prior to delivery of each dose of radiation. Ourcompact linear accelerator, or linac, is a compact radiation treatment device that uses microwaves to accelerate electrons to create high-energy X-raybeams to destroy the tumor. This combination, which we refer to as intelligent robotics, extends the benefits of radiosurgery to the treatment of tumorsanywhere in the body. The CyberKnife system autonomously tracks, detects and corrects for tumor and patient movement in real-time during theprocedure, enabling delivery of precise, high dose radiation typically with sub-millimeter accuracy. The CyberKnife procedure requires no anesthesia,can be performed on an outpatient basis and allows for the treatment of patients that otherwise would not have been treated with radiation or who maynot have been good candidates for surgery. In addition, the CyberKnife procedure avoids many of the potential risks and complications that areassociated with other treatment options and is more cost effective than traditional surgery. In July 1999, we obtained 510(k) clearance from the FDA to market the CyberKnife system for the treatment of tumors and certain otherconditions in the head, neck and upper spine. In August 2001, we received FDA clearance for the treatment of tumors anywhere in the body whereradiation treatment is indicated. In September 2002, we received a CE mark for the sale of the CyberKnife system in Europe. We received approval forfull-body treatment in Japan in June 2008; previously our CyberKnife regulatory approvals in Japan were limited to treatment for indications in the headand neck. The CyberKnife system has also been approved for various indications in Korea, Taiwan, China and other countries. Our customers havereported that over 50,000 patients worldwide have been treated with the CyberKnife system since its commercial introduction. In the United States, we sell to customers, including hospitals and stand-alone treatment facilities, directly through our sales organization. Outsidethe United States, we sell to customers in over 50 countries directly and through distributors. We have sales and service offices in Paris, France, HongKong, China, Tokyo, Japan, Madrid, Spain, New Delhi, India and Singapore. As of June 30, 2008, we had 61 sales personnel in our sales organization. Our CyberKnife systems are either sold to our customers or placed with our customers pursuant to our shared ownership program. As of June 30,2008, we had 140 CyberKnife systems installed at customer sites, including 137 sold and three pursuant to our shared ownership program. Of the 140systems sold and installed, 90 are in the Americas, 38 are in Asia and 12 are in Europe. Under our shared ownership program, we retain title to the CyberKnife system while the customer has use of the system. Our shared ownershipcontracts generally require a minimum monthly payment from the customer, and we may earn additional revenue through the use of the system at thesite. Generally, minimum monthly payments are equivalent to the revenue generated from treating three to four patients per month, and any revenuereceived from additional patients is shared between us and54the customer. We expect to continue to offer our shared ownership program to new customers and believe the number of installed units pursuant to andrevenue from our shared ownership program to increase in future periods, but to decrease as a percentage of total revenue as we recognize more revenuefrom CyberKnife systems sold to customers. The shared ownership program typically has a term of five years, during which the customer has the option to purchase the system at pre-determined prices. At June 30, 2008, we had three systems installed under our shared ownership program. During the years ended June 30, 2008 and2007, $23.7 million and $3.0 million, respectively, of total revenue was recognized in the consolidated statements of operations for the sale of 12 andone CyberKnife system units, respectively, that were formerly under our shared ownership program. At June 30, 2008 and 2007, $2.3 million and$50,000, respectively, of amounts for extended warranty and training services related to these sold shared ownership units remained recorded asdeferred revenue, and will be recognized over the life of the extended warranty service period and as training service obligations are fulfilled. We manufacture and assemble our CyberKnife systems at our manufacturing facility in Sunnyvale, California. We purchase major components,including the robotic manipulator, the treatment table or robotic couch, the magnetron, which creates the microwaves for use in the linear accelerator, theimaging cameras and the computers, from outside suppliers, some of which are single source. Our reliance on single source suppliers could harm ourability to meet demand for our products in a timely and cost effective manner. However, in most cases, if a supplier were unable to deliver thesecomponents, we believe that we would be able to find other sources for these components subject to any regulatory qualifications, if required. Wemanufacture certain other electronic and electrical subsystems, including the linear accelerator. We then assemble and integrate these components withour proprietary software and perform testing prior to shipment to customer sites. We generate revenue by selling the CyberKnife system and by providing ongoing services and upgrades to customers following installation of theCyberKnife system. The current United States list price for the CyberKnife system ranges from approximately $4.2 million to $5.75 million dependingupon system configuration and options purchased by the customer. The list price typically includes initial training, installation, and a one-year warranty.We also offer optional hardware and software, technical enhancements and upgrades to the CyberKnife system, as part of our multiyear service plans.Currently, our most comprehensive service plan is our Diamond Elite multiyear service plan, or Diamond plan. Under our Diamond plan, customers areeligible to receive up to two upgrades per year, when and if available. Through June 30, 2008, the Diamond Plan listed for $460,000 per year andprovided for annual renewals for four years including the one-year warranty period. Effective July 1, 2008, the Diamond plan lists for $495,000 peryear and provides for annual renewals for five years including the one-year warranty period. The customer may cancel the service plan at any time. Asof June 30, 2008, 107 of our customers had purchased service plans. Prior to introducing our Diamond plan, we offered legacy service plans, some ofwhich continue to have future upgrade obligations. In these cases, revenue, including Cyberknife product revenue, is recognized ratably over theremaining life of the contract once all upgrade obligations have been satisfied. The CyberKnife procedure is currently covered and reimbursed by Medicare and other governmental and non-governmental third-party payors.Medicare coverage currently exists in the hospital outpatient setting and in the free-standing clinic setting. For 2007, the CMS issued a final rule thatresulted in a downward adjustment to the reimbursement rates for treatments using our technology in the hospital outpatient department. For 2007,under the finalized Medicare payment rules, the national payment rates for procedures billed using Medicare billing codes for treatments using theCyberKnife system are $3,896 for the first treatment and $2,645 for each treatment thereafter, up to a maximum of five treatments, which is anapproximately 25 to 29 percent reduction as compared to 2006 payment rates. The implementation of this reimbursement reduction did not have amaterial impact on our consolidated financial position or results of operations for the year ended June 30, 2007. For the calendar year 2008, CMS haspublished increased payment rates as compared to 2007. The published55rates for the calendar year 2008 are $3,930 for the first treatment and $2,871 for each treatment thereafter. In July 2008, CMS issued proposed paymentrates under these codes for 2009. The proposed payment rate under HCPCS code G0339 for 2009 is $3,664 and the proposed payment rate under codeG0340 for 2009 is $2,654. We do not anticipate a significant impact of this rule on our business or results of operations. Our total net revenue was $210.4 million, $140.5 million and $52.9 million during the years ended June 30, 2008, 2007 and 2006, respectively.Our net income (loss) was $5.4 million, ($5.6) million and ($33.7) million during the years ended June 30, 2008, 2007 and 2006, respectively. Our netcash provided by (used in) operating activities was ($18.0) million, $11.6 million and $22.1 million during the years ended June 30, 2008, 2007 and2006, respectively. As of June 30, 2008, our backlog as discussed under "Backlog", was approximately $647.0 million. The contingent portion ofbacklog was $187.3 million at June 30, 2008. Contingent backlog consists of backlog under contracts that are subject to the satisfaction of contingenciesprior to the customer becoming legally bound to proceed with the acquisition of a CyberKnife system. The non-contingent portion of backlog was$459.7 million at June 30, 2008. Our future success will depend in large part on our ability to establish and maintain a competitive position in the market. To compete successfully,we will need to continue to demonstrate the advantages of our products and technologies over alternative procedures, products and technologies, andconvince physicians and other healthcare decision makers of the advantages of our products and technologies. Our business and sales and installationcycle does not immediately create recognizable revenue. As such, we must invest in sales and marketing activities up to 24 months prior to realizing therevenue from those activities. Our ability to achieve and maintain long-term profitability is largely dependent on our ability to successfully market andsell the CyberKnife system and to control our costs and effectively manage our growth.Material Weakness in Internal Controls In connection with our evaluation of internal controls over financial reporting, we identified a material weakness relating to accounting for revenuetransactions. Our efforts to remediate this material weakness in our internal controls over financial reporting consist of the following corrective actions: (i) hiringand training additional, qualified finance and accounting personnel; and (ii) strengthening our processes and procedures related to complex revenuerecognition transactions. However, even after these corrective actions are implemented, the effectiveness of our controls and procedures may be limitedby a variety of risks. Although we have taken measures to remediate previously reported material weaknesses as well as other significant deficiencies and controldeficiencies, we cannot assure you that we have identified all, or that we will not in the future have additional material weaknesses, significantdeficiencies and control deficiencies.Financial OperationsSales and Installation Cycle The CyberKnife system has a relatively long sales and installation cycle because it is a major capital item and requires the approval of seniormanagement at purchasing institutions. The typical sales and installation cycle is up to 24 months in duration and involves multiple steps. Initial stepsmay include pre-selling activity followed by sales presentations and other sales related activities. After the customer has expressed an intention topurchase a CyberKnife system, we typically negotiate and enter into a terms agreement setting forth the business and economic terms for the sale oracquisition of the CyberKnife system and multiyear service plan. After execution of a terms agreement, the customer typically has a specified timewindow in which to complete final negotiation of legal terms for the sale or acquisition of the CyberKnife system. We bifurcated the process ofnegotiating agreements on56business and legal terms in order to reduce the level of sales force involvement in negotiation of legal terms and improve the efficiency of our customercontracting process. Nevertheless, many customers, particularly in international markets, opt to negotiate a full purchase agreement at the time of sale.The last step in the sales and installation cycle is installation of the CyberKnife system. Prior to installation, a purchasing institution must typically obtaina radiation device installation permit, and in some cases, a certificate of need, or CON, both of which must be granted by state and local governmentbodies. Recently, as a result of healthcare cost considerations and sensitivity to the cost of major capital equipment items, some state CON boards havebecome more aggressive in the evaluation of CON applications. This trend, if it continues, may make the CON process more protracted and uncertain.In addition, the purchasing institution must build a radiation shielded facility or upgrade an existing facility to house the CyberKnife system. Wetypically receive a deposit at the time the terms agreement or full purchase agreement is entered into, or shortly thereafter, and the remaining balance forthe sale of the CyberKnife system upon delivery and installation. The customer also typically selects a service plan at the time of signing a CyberKnifesystem terms agreement and enters into the service plan agreement prior to installation of the system. Upon installation, we typically recognize the CyberKnife system sale price less the fair value of one year of service. We recognize the fair value ofthe first year of service as revenue pro rata over the twelve months following installation. In addition, if the customer has purchased our Diamond planand assuming annual renewals, we would receive payment at the beginning of each of the second, third and fourth years of the multiyear service planand recognize that revenue pro rata over each year.Legacy Service Plans Prior to introducing our Diamond plan, we offered a Platinum Elite multiyear service plan, or Platinum plan. These legacy service plans werestructured so that we have an obligation to deliver two upgrades per year over the course of the multiyear service plan. If we fail to deliver the upgrades,our customers are entitled to receive a refund of up to $100,000 for each upgrade not offered. Beginning in November 2005, we phased out offeringthese legacy service plans to new customers. The Platinum plan obligates us to deliver two upgrades per year during the term of the contract. We have not established fair value for those futureobligations; hence, generally accepted accounting principles in the United States, or GAAP, requires that we cannot begin to recognize any of therevenue derived from the sale of the CyberKnife system or the associated service plans until all upgrade obligations have been fulfilled. Therefore, thepayments made by our customers who have our legacy Platinum plan are categorized as deferred revenue and are recognized as revenue after we fulfillall obligations to deliver upgrades. Once we fulfill all upgrade obligations with respect to a specific Platinum plan, we ratably recognize the revenuefrom the sale of the CyberKnife system and the Platinum plan over the remaining life of the contract.Upgrades Customers may purchase additional upgrades as optional extras prior to the delivery of all originally specified upgrade obligations. Such additionalupgrades are considered elements of the original arrangement and associated revenues are deferred until the earlier of: (1) delivery of all elements, or(2) establishment of VSOE of fair value for all undelivered elements. Sales of additional upgrades after delivery of all specified upgrade obligations, asstated in the original contract, are considered separate arrangements and are recognized once all revenue recognition criteria applicable to the separatearrangements are met.Warranty All customers purchasing a CyberKnife system receive a one-year warranty. In circumstances where we have VSOE of fair value for allundelivered elements, we recognize the CyberKnife system purchase57price minus the fair value of one year of support upon installation, and we recognize the value of one year of support ratably over the twelve monthsfollowing installation.Shared Ownership Program Revenue As of June 30, 2008, our shared ownership program involved U.S. sites only. We recognize revenue monthly from our shared ownership programthat consists of a minimum monthly payment. We also recognize usage-based revenue in excess of the monthly minimum based on usage reports fromour customers. We recognized revenue from our shared ownership program of $10.3 million, $10.1 million and $8.1 million for the years endedJune 30, 2008, 2007 and 2006, respectively. In limited cases, we received nonrefundable upfront payments from shared ownership program customerswhich are treated as deferred revenue and recognized over the term of the contract. The CyberKnife system shared ownership systems are recorded within property and equipment and are depreciated over their estimated life of tenyears. Depreciation and warranty expense attributable to shared ownership systems are recorded within cost of shared ownership program as they areincurred.Japan Customized Service Revenue In May and December 2003, we entered into separate contractual arrangements to deliver customized upgrade services to our distributor in Japanfor 22 CyberKnife systems previously sold. These customized upgrade services consist of two upgrade levels and are being delivered over an extendedperiod concurrent with the distributor's efforts to coordinate delivery with their end user customers. Once the obligations under the upgrade programsfor these 22 systems are complete, we do not plan to offer this customized service program and will instead be offering our standard multiyear serviceplans.International Sales Revenue For international sales, we recognize revenue once we have met all of our obligations associated with the purchase agreement, other than forundelivered service elements for which we have vendor specific objective evidence, or VSOE, of fair value. In most cases, this occurs after thedistributor has shipped the unit to the end user, assuming all of our remaining obligations have been satisfied. Payments are sometimes secured throughletters of credit. In situations where we are directly responsible for installation, we recognize revenue once we have installed the CyberKnife system andhave confirmed performance against specification. In situations with legacy plans where we have future obligations related to software upgrades that are subject to potential refunds, we defer revenuefrom the sale and service of the CyberKnife system until the final upgrade has been delivered and accepted. After we have delivered all upgradesassociated with a service plan and thus eliminated any contractual right to a refund, we ratably recognize the revenue from the sale of the CyberKnifesystem and the plan over the remaining life of the contract or until we have VSOE of the fair value of remaining undelivered elements. Net revenue frominternational customers was $67.8 million, $49.3 million and $12.1 million for the years ended June 30, 2008, 2007 and 2006, respectively.Backlog Backlog consists of the sum of deferred revenue, future payments that our customers are contractually committed to make and signed contingentcontracts that we believe have a substantially high probability of being booked as revenue from CyberKnife system sale agreements, service plans andminimum payment requirements associated with our shared ownership program. Contingencies associated with contingent contracts that are includedwithin backlog may include state or local government approval of a certificate of need for the installation of a radiosurgery system, approval by theboard of directors of the hospital or other purchaser of the system and establishment of financing58and formation of legal entities by purchasers of systems and, in the case of terms agreements, final negotiation and agreement upon our legal terms forthe purchase or acquisition of the CyberKnife system. In addition, in some cases in which customers negotiate full purchase agreements, theseagreements are also subject to certain contingencies. We review, on a quarterly basis with respect to each contingent contract included in backlog,whether customer engagement and progress toward satisfaction of contingencies warrant continued inclusion of the contract within backlog. As of June 30, 2008, our backlog, as defined above, was approximately $647.0 million. Of the total backlog, $358.6 million representedCyberKnife system sales, and $288.4 million represented revenue from service plans and other recurring revenues. The contingent portion of backlogwas $187.3 million at June 30, 2008. Contingent backlog consists of backlog under contracts that are subject to the satisfaction of contingencies prior tothe customer becoming legally bound to proceed with the acquisition of a CyberKnife system. The non-contingent portion of backlog was$459.7 million at June 30, 2008. We anticipate that this backlog will be recognized over the next five years as installations occur, upgrades are deliveredand services are provided. Although backlog includes contractual commitments from our customers, we may be unable to convert this entire backlog,including the entire non-contingent backlog, into recognized revenue due to factors outside our control.Results of OperationsOverview Our results of operations are divided into the following components: Net revenue. Our net revenue consists primarily of product revenue (revenue derived primarily from the sale of CyberKnife systems and thesale of linacs for other uses), shared ownership program revenue (revenue generated from our shared ownership program), services revenue (revenuegenerated from sales of service plans and training) and other revenue (revenue from specialized upgrade services for units previously sold in Japan andother specialized services). Cost of revenue. Cost of revenue consists primarily of material, labor and overhead costs. In future periods we expect cost of revenue todecrease as a percentage of total net revenue due to anticipated higher-margin product sales and increased absorption of manufacturing overhead costsassociated with increased production volumes, improved efficiencies for supplies and materials and improved labor and manufacturing efficiencies. Selling and marketing expenses. Selling and marketing expenses consist primarily of costs for personnel and costs associated withparticipation in medical conferences, physician symposia, and advertising and promotional activities. In future periods, we expect selling and marketingexpenses to grow in absolute terms as we increase headcount and further increase participation in trade shows and symposia and invest in othermarketing and promotional activities; but to decrease as a percentage of total net revenue as we leverage our existing infrastructure and realize economiesof scale. Marketing expenses may fluctuate from quarter to quarter due to the timing of major marketing events, such as significant trade shows. Research and development expenses. Research and development expenses consist primarily of activities associated with our productdevelopment, regulatory, and clinical study arrangements. In future periods, we expect research and development expenses to grow in absolute terms aswe continue our investment in new technologies, enhancements to the CyberKnife system, increased clinical studies, and as we increase headcount anddevelopment activities. Our objective is to manage growth in these expenditures such that they will decrease as a percentage of total net revenue as weleverage our existing infrastructure and realize economies of scale. General and administrative expenses. General and administrative expenses consist primarily of compensation and related costs for finance,legal, and human resources, and external expenses related to accounting, legal and other consulting fees. In future periods, we expect general andadministrative59expenses to grow in absolute terms as we incur additional costs related to the overall growth of our business. Our objective is to manage growth inthese expenditures such that they will decrease as a percentage of total net revenue as we leverage our existing infrastructure and realize economies ofscale. Interest and other income. Interest and other income consist primarily of interest earned on our cash and cash equivalents and investments.We expect interest income to decrease in the near future in response to the recent decline in interest rates and lower invested cash balances. Interest and other expense. Interest and other expense consist primarily of losses from the disposal of property and equipment, state and localsales and use taxes, interest payments and foreign currency transaction losses.Deferred Revenue—Legacy Multiyear Service Plans We are required to defer all of the revenue associated with our legacy multiyear service plans, including our Platinum and Gold service plans, untilwe have satisfied all of the specified obligations related to the delivery of upgrades to the CyberKnife system during the life of the service plan. Thisincludes deferring the cash received for the purchase of the CyberKnife system and multiyear service plans until we have delivered all upgrades whichthe customer is eligible to receive. Once we have satisfied our obligations for delivery of upgrades under the plans, we recognize revenue ratably overthe remaining life of the service plan. We have not offered these legacy multiyear service plans to new customers since we phased them out when weintroduced our Diamond plan in November 2005, but continue to provide service for 44 legacy plans as of June 30, 2008. Therefore, our deferredrevenue has been higher in certain periods where we have installed more units with legacy contracts, and it should decrease in future periods as wesatisfy the contractual obligations and recognize the revenue associated with those installed units. However, we do not anticipate receiving significantincremental cash flow from operations related to these legacy contracts.Years ended June 30, 2008, 2007 and 2006Net revenue. Years ended June 30, 2008 2007 2006 (in thousands) Net revenue $210,381 $140,452 $52,897 Products $152,374 $110,320 $36,089 Shared ownership program $10,262 $10,090 $8,145 Services $38,808 $16,860 $4,848 Other $8,937 $3,182 $3,815 Total net revenue for the year ended June 30, 2008 increased $69.9 million from the year ended June 30, 2007. During the year ended June 30,2008, 31 CyberKnife system units were installed, including 27 units sold and four attributable to our shared ownership program, compared to 33 unitsinstalled, including 31 units sold and two attributable to our shared ownership program in the year ended June 30, 2007. In accordance with our revenuerecognition policy and reflecting the terms of our service plans, we recognized revenue associated with the sale of 46 CyberKnife system units,including 12 units that had been in our shared ownership program, for the year ended June 30, 2008, compared to 32 CyberKnife system units,including one unit that had been in our shared ownership program, for the year ended June 30, 2007. Product revenue for the year ended June 30, 2008 increased $42.1 million from the year ended June 30, 2007. The increase was primarilyattributable to the sale of 12 CyberKnife systems that had been in our shared ownership program for an aggregate purchase price of $23.7 million. Also,during60the year ended June 30, 2008, we satisfied all revenue recognition criteria for seven units previously sold to a distributor in China and recognized$13.1 million of non-recurring product revenue related to these units. As of June 30, 2007, revenue associated with these units was recorded in deferredrevenue. In addition, we recognize revenue ratably over the remaining lives of the service plans for those legacy multiyear service plans where we havesatisfied our upgrade delivery obligations. During the years ended June 30, 2008 and 2007, we recognized product revenue attributable to these legacymultiyear plans for 18 units and 11 units, respectively. We have recognized all of the product revenue attributable to these legacy multiyear plans for onesystem during each of the years ended June 30, 2008 and 2007. Service revenue for the year ended June 30, 2008 increased approximately $21.9 million from the year ended June 30, 2007, primarily attributableto an increase in the number of customer sites under service plans. Shared ownership program revenue for the year ended June 30, 2008 increasedapproximately $172,000 from the year ended June 30, 2007. We anticipate revenue from our shared ownership program will decrease in future periodsdue to the sale of 14 units that had been in our shared ownership program through the year ended June 30, 2008. Revenue from upgrade services inJapan, classified as "Other revenue" in our consolidated statements of operations for the year ended June 30, 2008, increased approximately$5.8 million from the year ended June 30, 2007 due to an increase in upgrade services provided to our installed systems in Japan. Total net revenue for the year ended June 30, 2007 increased $87.6 million from the year ended June 30, 2006. During the year ended June 30,2007, 33 CyberKnife system units were installed, including 31 units sold and two units attributable to our shared ownership program, compared to 28units installed, including 25 units sold and three units attributable to our shared ownership program during the year ended June 30, 2006. In accordancewith our revenue recognition policy and reflecting the terms of our service plans, we recognized revenue from the sale of 32 CyberKnife system units,including one unit that had been in our shared ownership program, for the year ended June 30, 2007 and 11 CyberKnife systems during the year endedJune 30, 2006. Products revenue for the year ended June 30, 2007 increased $74.2 million from the year ended June 30, 2006, primarily attributable to an increasein the number of CyberKnife system units shipped and installed and a change in the mix of service plans. In addition, we recognize revenue ratably overthe remaining lives of the service plans for those legacy multiyear service plans where we have satisfied our upgrade delivery obligations. During theyears ended June 30, 2007 and 2006, we recognized product revenue attributable to these legacy multiyear plans for 11 units and one unit, respectively.We had recognized all of the product revenues attributable to these legacy multiyear plans for one system during the year ended June 30, 2007. No unitsattributable to the legacy multiyear plans were fully recognized during the year ended June 30, 2006. Shared ownership revenue for the year ended June 30, 2007 increased $1.9 million from the year ended June 30, 2006, primarily due to anincrease in patient treatment volume at the existing sites as well as an increase in the number of shared ownership sites. Services revenue for the yearended June 30, 2007 increased $12.0 million from the year ended June 30, 2006, primarily attributable to an increase in the number of customer sitesunder service plans. Revenue from upgrade services in Japan, classified as "Other revenue" in our consolidated statements of operations, for the yearended June 30, 2007 decreased by $633,000 from the year ended June 30, 2006, due to a decrease in upgrade services provided to our installed systemsin Japan.61Cost of revenue. Years ended June 30, 2008 2007 2006 (Dollars in thousands) Cost of revenue $103,429 $60,413 $27,492 % of net revenue 49.2% 43.0% 52.0% Gross Margin % 50.8% 57.0% 48.0% Total cost of revenue for the year ended June 30, 2008 increased $43.0 million from the year ended June 30, 2007. The increase was primarilyattributable to the sale of 12 CyberKnife system units that had been in our shared ownership program and an increased number of customer sites underservice plans during the year ended June 30, 2008 compared to the year ended June 30, 2007. As a percentage of total net revenue, total cost of revenuefor the year ended June 30, 2008 increased to 49.2% as compared to 43.0% for the year ended June 30, 2007. The increase in total cost of revenue as apercentage of total net revenue was due primarily to the sale of CyberKnife systems previously in our shared ownership program, an increase inCyberKnife system shipments through our distributor channel, and to a lesser extent, upgrade services provided to our installed systems in Japan, whichall typically have lower gross margins than conventional CyberKnife unit sales. Total cost of revenue for the year ended June 30, 2007 increased $32.9 million from the year ended June 30, 2006. The increase was primarilyattributable to an increase in the number of CyberKnife systems installed and recognized as revenue during fiscal year 2007 compared to fiscal year2006. As a percentage of total net revenue, total cost of revenue for the year ended June 30, 2007 decreased to 43.0% as compared to 52.0% for the yearended June 30, 2006. The decrease in total cost of revenue as a percentage of total net revenue from fiscal year 2006 to fiscal year 2007 was a result ofimproved absorption of manufacturing overhead costs associated with increased production volumes of CyberKnife systems and the significant increasein product revenue from CyberKnife unit sales, which typically has a lower cost of revenue as a percentage of revenue than other revenue streams.Selling and marketing expenses. Years ended June 30, 2008 2007 2006 (Dollars in thousands) Sales and marketing $42,726 $37,889 $25,186 % of net revenue 20.3% 27.0% 47.6% Selling and marketing expenses for the year ended June 30, 2008 increased $4.8 million from the year ended June 30, 2007. The increase wasprimarily attributable to an increase of $3.1 million in salary and related costs, including stock-based compensation, largely due to increased headcountand an increase of $1.7 million in facility and operational costs as a result of the continuing expansion of our international sales presence. Selling and marketing expenses for the year ended June 30, 2007 increased $12.7 million from the year ended June 30, 2006. The increase wasprimarily attributable to an increase of $5.2 million in salary and related costs, including stock-based compensation, largely due to increased headcount,an increase of $3.3 million in consulting expenses due to an increase in promotional activities, an increase of $1.8 million in marketing and promotionalactivities, an increase of $1.2 million in travel expense, and an increase of $914,000 in sales commissions expenses resulting from increased salesvolume.62Research and development expenses. Years ended June 30, 2008 2007 2006 (Dollars in thousands) Research and development $32,880 $26,775 $17,788 % of net revenue 15.6% 19.1% 33.6% Research and development expenses for the year ended June 30, 2008 increased $6.1 million from the year ended June 30, 2007. The increase wasprimarily attributable to an increase of $5.2 million in salary and related costs, including stock-based compensation, largely due to increased headcount,an increase of $1.3 million in consulting and outside services related to increased research and development activity for various CyberKnife projects,and an increase of $819,000 in non-inventory materials and other operational costs as a result of increasing our research and development activity forvarious CyberKnife projects. Research and development expenses for the year ended June 30, 2007 increased $9.0 million from the year ended June 30, 2006. The increase wasprimarily attributable to an increase of $6.6 million in salary and related costs, including stock-based compensation expense, largely due to increasedheadcount, an increase of $1.5 million in purchases of non-inventory materials, an increase in consulting and outside services of $227,000 and anincrease of $214,000 in travel expenses.General and administrative expenses. Years ended June 30, 2008 2007 2006 (Dollars in thousands) General and administrative $32,280 $23,915 $15,923 % of net revenue 15.3% 17.0% 30.1% General and administrative expenses for the year ended June 30, 2008 increased $8.4 million from the year ended June 30, 2007. The increase wasprimarily attributable to an increase of $6.9 million in salary and related costs, including stock-based compensation, largely due to increased headcountand an increase in stock-based compensation charges associated with option grants to purchase common stock, and an increase of $1.5 million in othercorporate administration costs from being a public company for all of fiscal 2008 compared to five months in fiscal 2007. General and administrative expenses for the year ended June 30, 2007 increased $8.0 million from the year ended June 30, 2006. The increase wasprimarily attributable to an increase of $7.0 million in salary and related costs, including stock-based compensation, an increase of $567,000 in suppliesand materials and an increase of $343,000 in travel expense, all due primarily to increased headcount.Interest and other income. Years ended June 30, 2008 2007 2006 (Dollars in thousands) Interest and other income $7,841 $4,261 $503 % of net revenue 3.7% 3.0% 1.0%63 Interest and other income for the year ended June 30, 2008 increased $3.6 million from the year ended June 30, 2007. The increase was primarilydue to higher average daily balances kept in interest bearing accounts, as a result of receiving proceeds from our initial public offering, or IPO, inFebruary 2007, for 12 months during the year ended June 30, 3008 compared to only five months during the year ended June 30, 2007. Interest and other income for the year ended June 30, 2007 increased $3.8 million from the year ended June 30, 2006. The increase was primarilydue to the receipt of proceeds from our IPO in February 2007 which resulted in higher average daily balances kept in interest bearing accounts for thefive months following our IPO during the year ended June 30, 2007.Interest and other expense. Years ended June 30, 2008 2007 2006 (Dollars in thousands) Interest and other expense $657 $731 $447 % of net revenue 0.3% 0.5% 0.8% Interest and other expense for the year ended June 30, 2008 was consistent with a slight decrease of $74,000 compared with year ended June 30,2007. Interest and other expense for the year ended June 30, 2007 increased $284,000 from the year ended June 30, 2006. The increase in fiscal year2007 compared to fiscal year 2006 was primarily due to an increase in loss from the disposal of property and equipment and an increase in loss fromforeign exchange transactions, offset by a decrease in interest expense on advance payments received from third-party financing arrangements inconnection with our shared ownership program. Cumulative effect of change in accounting principle. For the year ended June 30, 2007, we recorded the cumulative effect of a change inaccounting principle of $838,000 related to our adoption effective July 1, 2006, of Statement of Financial Accounting Standards, or SFAS No. 123R,Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95, or SFAS 123R, related to our accounting for stock-based compensation.We had previously accounted for our stock-based compensation expense in accordance with SFAS No. 123, Accounting for Stock-BasedCompensation, or SFAS 123, which permitted us to either estimate forfeitures in determining our stock-based compensation expense or to adjust theexpense at the time forfeitures occurred. SFAS 123R requires that we estimate forfeitures. Since we had previously adjusted our stock-basedcompensation expense at the time forfeitures occurred, we have included in our consolidated statement of operations for the year ended June 30, 2007the cumulative effect of a change in accounting principle for the adjustment to reflect forfeitures related to compensation expense recorded in priorperiods.Provision for income taxes. Years ended June 30, 2008 2007 2006 (Dollars in thousands) Provision for income taxes $867 $1,444 $258 % of net revenue 0.4% 1.0% 0.5% The provision for income taxes for the year ended June 30, 2008 decreased $577,000 from the year ended June 30, 2007. In fiscal 2008, werecorded a decrease in foreign taxes of $58,000 as compared to the prior year as the result of the recognition of tax benefits associated with theutilization of foreign net operating losses. We also recorded a decrease in federal and state alternative minimum taxes, or AMT, of $519,000 primarilydue to a decrease in taxable income resulting from an increase in stock64option deductions available under SFAS 123R in the current year and decreased recognition of revenue for tax purposes. The provision for income taxes increased $1.2 million from fiscal year 2006 to fiscal year 2007. We recorded an increase in foreign taxes of$308,000 as compared to fiscal 2006 primarily due to increased activity and higher net income in our foreign jurisdictions. We also recorded an increasein federal and state AMT of $878,000 primarily due to the increased recognition of revenue for tax purposes while such revenue was deferred forfinancial statement purposes. As of June 30, 2008, we had federal and state net operating loss carryforwards of $23.8 million and $16.5 million, respectively. These federal andstate net operating loss carryforwards are available to offset against future taxable income, if any, in varying amounts and will begin to expire beginningin 2019 and 2013 for federal and state purposes, respectively. Such net operating loss carryforwards include excess tax benefits from employee optionexercises that have not been recorded in our deferred tax assets, which is in accordance with SFAS 123R. We will record approximately $9.2 million asa credit to additional paid in capital if and when such excess benefits are ultimately realized. We also had federal and state research and development taxcredit carryforwards of approximately $3.9 million and $4.8 million, respectively. If not utilized, the federal tax credit carryforwards will expire in 2025,while the state tax credits have no expiration date. In addition, among other matters, realization of the entire deferred tax asset is dependent on our abilityto generate sufficient taxable income prior to the expiration of the carryforwards. While we had taxable income in 2008, based on the available objectiveevidence and the history of losses, we cannot conclude that the net deferred tax assets will more likely than not be realized. Accordingly, we haverecorded a valuation allowance against our domestic and foreign net deferred tax assets. At June 30, 2008, there was no provision for U.S. income tax for undistributed earnings as it is currently our intention to reinvest these earningsindefinitely in operations outside the U.S. If repatriated, these earnings could result in a tax expense at the current U.S. Federal statutory tax rate of 35%,subject to available net operating losses and other factors. Subject to limitation, tax on undistributed earnings may also be reduced by foreign tax creditsthat may be generated in connection with the repatriation of earnings. We adopted FASB Interpretation No. 48, Accounting for uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, or FIN 48,on July 1, 2007. See Note 9 to the Consolidated Financial Statements for a detail description.Stock-Based Compensation Expense Effective July 1, 2006, we adopted SFAS 123R using the modified prospective method under which compensation cost is recognized beginningwith the effective date (a) based on the requirements of SFAS 123R for all share-based payments granted or modified after the effective date and(b) based on the previous requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R that remain unvestedon the effective date. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cashflow, rather than as an operating cash flow as required under previous literature. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary in subsequent periods if actual forfeitures differ frominitial estimates. Stock-based compensation expense was recorded net of estimated forfeitures for the years ended June 30, 2008 and 2007 such thatexpense was recorded only for those stock-based awards that are expected to vest. For the years ended June 30, 2008 and 2007, we recorded$16.9 million and $12.6 million, respectively, of stock-based compensation expense, net of estimated forfeitures, for stock options, 2007 EmployeeStock Purchase Plan, or ESPP, options and restricted stock units granted to employees.65 For the year ended June 30, 2007, we recorded the cumulative effect of a change in accounting principle of $838,000 related to the adoption ofSFAS 123R since we had previously adjusted stock-based compensation expense at the time forfeitures occurred in accordance with SFAS 123. Thecumulative effect of this change in accounting principle reflects estimated forfeitures related to periods prior to July 1, 2006. As of June 30, 2008, there was approximately $41.0 million, net of estimated forfeitures, of unrecognized compensation cost related to unvestedstock options, ESPP options and restricted stock units which we expect to be recognized over a weighted average period of 2.48 years. Prior to July 1, 2006, stock-based compensation expense was reflected on our statement of operations in accordance with SFAS 123 and SFASNo. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, or SFAS 148. In accordance with the requirements of SFAS 123,we recorded deferred stock-based compensation for the estimated fair value of options awarded on the date of grant. This deferred stock-basedcompensation was amortized to expense over the period during which the options become exercisable, generally four years. During the year endedJune 30, 2006 we recorded $7.9 million of stock-based compensation expense for stock options granted to employees. During the years ended June 30, 2008, 2007 and 2006, we recognized $114,000, $171,000 and $186,000 of stock-based compensation expense,respectively, for stock options granted to non-employees. For certain stock option grants, we made modifications to the option terms. Thesemodifications included extensions of the vesting period and acceleration of vesting. During the years ended June 30, 2008, 2007 and 2006, werecognized $0, $0 and $112,000 of stock-based compensation expense, respectively, for modifications of stock options granted.Liquidity and Capital Resources At June 30, 2008, we had $36.9 million in cash and cash equivalents. During the year ended June 30, 2008, cash and cash equivalents decreasedby $167.9 million. This decrease was primarily attributable to cash used in operating activities of $18.0 million, stock repurchases of $24.0 million andthe investment of our excess cash and cash equivalents in higher-yielding investment accounts. Short-term investments amounted to $85.5 million andnone at June 30, 2008 and 2007, respectively. Long-term investments amounted to $37.0 million and none at June 30, 2008 and 2007, respectively. Webelieve that we have sufficient cash resources and anticipated cash flows to continue in operation for at least the next 12 months. In February 2007, we completed our initial public offering in which a total of 18,399,998 shares were sold, including 8,000,000 shares sold byselling stockholders at an initial public offering price of $18.00 per share. We raised a total of $187.2 million in gross proceeds, or approximately$170.6 million in net proceeds after deducting underwriting discounts and commissions of $13.1 million and other offering costs of $3.5 million.Years ended June 30, 2008, 2007 and 2006 Cash Flows From Operating Activities. Net cash used in operating activities was $18.0 million for the year ended June 30, 2008. Our netincome of $5.4 million during fiscal year 2008 was offset by an increase in accounts receivable of $23.9 million, a decrease in deferred revenue, net ofdeferred cost of revenue, of $13.8 million, and an increase in inventories of $10.4 million. The increase in accounts receivable was primarily a result ofthe timing difference between the shipment of products and the receipt of customer payment. The decrease in deferred revenue, net of deferred cost ofrevenue, was primarily a result of the timing of differences between invoicing customers under service contracts and the recognition of revenue over thecontractual service period, the continued satisfaction of specified obligations to begin revenue recognition for units covered by our legacy service plansand the66recognition of revenue and cost of revenue for units previously shipped to a distributor in China. The increase in inventories was due primarily to anincrease in our business volume. Non-cash charges included $16.9 million of stock-based compensation and $7.7 million of depreciation andamortization expense. Net cash provided by operating activities was $11.6 million for the year ended June 30, 2007. Our net loss of $5.6 million during fiscal year 2007was offset by non-cash charges of $6.2 million of depreciation and amortization expense, and $12.6 million of stock-based compensation offset by thecumulative effect of a change in accounting principle of $838,000 due to the adoption of SFAS 123R. Other significant working capital changes thatcontributed to positive cash flows provided by operations in fiscal 2007 included an increase in accounts payables of $9.5 million, an increase inaccrued liabilities of $3.1 million and an increase in deferred revenue, net of deferred cost of revenue of $1.9 million. The increase in accounts payablewas due to increases in the volume of our business and the increase in accrued liabilities was due to increases in compensation related accruals due toincreased headcount. The increase in deferred revenue, net of deferred cost of revenue, was primarily a result of the timing differences betweeninvoicing customers under service contracts and the recognition of revenue over the contractual service period, and the continued satisfaction ofspecified obligations to begin revenue recognition for units covered by our legacy service plans. Offsets to positive cashflow included an increase ininventories of $8.8 million, an increase in prepaid expenses and other current assets of $5.1 million, and a decrease in customer advances of $1.5 milliondue to an increase in the number of systems shipped. Net cash provided by operating activities was $22.1 million for the year ended June 30, 2006. Our net loss of $33.7 million during fiscal 2006 wasoffset by a $39.6 million increase in deferred revenue, net of deferred cost of revenue, non-cash charges of $8.2 million related to stock-basedcompensation charges and $3.8 million of depreciation and amortization expense on purchases of property and equipment. The increase in deferredrevenue, net of deferred cost of revenue, was primarily a result of the timing differences between invoicing customers under service contracts and therecognition of revenue over the contractual service period, and the continued satisfaction of specified obligations to begin revenue recognition for unitscovered by our legacy service plans. Other significant working capital changes that contributed to positive cash flow in fiscal year 2006 included anincrease in customer advances of $10.9 million due to increased payments made by customers in advance of product shipments and an increase inaccrued liabilities of $9.4 million primarily due to increases in accrued commissions on higher revenues and other compensation related accruals due toincreased headcount. Significant working capital changes that offset positive cash flows in fiscal year 2006 included an increase in accounts receivableof $6.6 million and an increase in inventory of $7.8 million as a result of increased revenues and volumes of orders from our customers. Cash Flows From Investing Activities. Net cash used in investing activities was $133.4 million for the year ended June 30, 2008 and wasattributable to net investment of our excess cash and cash equivalents in higher yielding investment accounts of $123.6 million, which consisted of$177.7 million of purchases and $54.1 million of sales and maturities of marketable securities, $5.0 million of purchases of property and equipment, and$4.8 million of restricted cash activity. The increase in investment activity during the year ended June 30, 2008 is due primarily to the January 2008investment of proceeds from our initial public offering in February 2007. The increase in restricted cash is due to arrangements in contracts withcustomers requiring that deposited cash amounts be secured via letter of credit until delivery of the CyberKnife unit occurs. Net cash used in investing activities was $7.5 million for the year ended June 30, 2007, which was primarily due to purchases of property andequipment of $7.2 million.67 Net cash used in investing activities was $9.0 million for the year ended June 30, 2006. The net cash used in investing activities in fiscal year 2006was primarily due to purchases of property and equipment of $10.2 million. Purchases of property and equipment in all periods were due to the expansion of our facilities and operations. Cash Flows From Financing Activities. Net cash used in financing activities was $16.2 million for the year ended June 30, 2008 and wasprimarily attributable to stock repurchases of $24.0 million, partially offset by proceeds from the exercise of common stock options of $4.4 million andproceeds from our ESPP of $3.0 million. Net cash provided by financing activities was $172.9 million for the year ended June 30, 2007 and was primarily attributable to net proceeds fromour initial public offering of $170.6 million and proceeds from the exercise of common stock options of $1.7 million. Net cash used in financing activities was $2.2 million for the year ended June 30, 2006 and was primarily due to the payment of a note payable of$3.0 million offset by proceeds from the exercise of common stock options and common stock warrants of $705,000.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 by sales of the CyberKnife system, our shared ownership program and service plans; •costs associated with our sales and marketing initiatives and manufacturing activities; •rate of progress and cost of our research and development activities; •costs of obtaining and maintaining FDA and other regulatory clearances of the CyberKnife system; •effects of competing technological and market developments; and •number and timing of acquisitions and other strategic transactions. We believe that our current cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capitalexpenditures for at least 12 months. If these sources of cash and cash equivalents are insufficient to satisfy our liquidity requirements, we may seek tosell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity or convertible debt securities could result indilution to our stockholders. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to thoseassociated with our common stock and could contain covenants that would restrict our operations. Additional financing may not be available at all, or inamounts or on terms acceptable to us. If we are unable to obtain this additional financing, we may be required to reduce the scope of our plannedproduct development and marketing efforts.68Contractual Obligations and Commitments The following table is a summary of our non-cancelable contractual cash obligations, net of sublease income as of June 30, 2008: Payments due by period Total Less than1 year 1 - 3 years 3 - 5 years (in thousands) Operating leases $9,150 $4,875 $4,234 $41 Sublease income $(162)$(162)$— $— Total $8,988 $4,713 $4,234 $41 Off Balance Sheet Arrangements We do not have any off balance sheet arrangements.Inflation We do not believe that inflation has had a material impact on our business and operating results during the periods presented.Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have beenprepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and judgmentsthat affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financialstatements, as well as revenue and expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base ourestimates on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis formaking judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could therefore differmaterially from those estimates under different assumptions or conditions. Our significant accounting policies are more fully described in the notes to our consolidated financial statements included elsewhere in this report.We believe the following are our critical accounting policies including the more significant estimates and assumptions used in preparation of ourconsolidated financial statements.Revenue Recognition We earn revenue from the sale of our products, our shared ownership program, and the provision of related services, which can include installationservices, post-contract customer support, or PCS, training and consulting. Our products and upgrades to those products include software that isessential to the functionality of the products and accordingly, we account for the sale of our products pursuant to Statement of Position No. 97-2,Software Revenue Recognition, or SOP 97-2, as amended. We recognize product revenues for sales of the CyberKnife system, replacement parts and accessories when there is persuasive evidence of anarrangement, the fee is fixed or determinable, collection of the fee is probable and delivery has occurred as prescribed by SOP 97-2. Payments receivedin advance of product shipment are recorded as customer advances and are recognized as revenue or deferred revenue upon product shipment orinstallation.69 For arrangements with multiple elements, we allocate arrangement consideration to services and PCS based upon vendor specific objectiveevidence, or VSOE, of fair value of the respective elements. VSOE of fair value for the services element is based upon our standard rates charged forthe products or services when such products or services are sold separately or based upon the price established by management having the relevantauthority when that service is not yet being sold separately. When contracts contain multiple elements, and VSOE of fair value exists for all undeliveredelements, we account for the delivered elements, principally the CyberKnife system, based upon the "residual method" as prescribed by SOP No. 98-9,Modification of SOP No. 97-2 with Respect to Certain Transactions, or SOP 98-9. If VSOE of fair value does not exist for all the undeliveredelements, all revenue is deferred until the earlier of: (1) delivery of all elements, or (2) establishment of VSOE of fair value for all undelivered elements.CyberKnife Sales with Legacy Service Plans For sales of CyberKnife systems with PCS arrangements that include specified or committed upgrades for which we have not established VSOEof fair value, all revenue is deferred until the specified or committed upgrades are delivered. In such cases, once all upgrade obligations have beendelivered, all deferred revenue is recognized ratably over the remaining life of the PCS arrangement. Sales of additional upgrades as optional extras prior to the delivery of all originally specified upgrade obligations are considered additionalelements of the original arrangement and associated revenues are deferred and accounted for as described above. Sales of additional upgrades afterdelivery of all specified upgrade obligations, as stated in the original contract, are recognized once all revenue recognition criteria applicable to thosearrangements are met.CyberKnife Sales with Nonlegacy Service Plans In fiscal year 2006, we began selling CyberKnife systems with PCS contracts that only provide for upgrades when and if they become available.We have established VSOE of the fair value of PCS in these circumstances. For arrangements with multiple elements that include the CyberKnifesystem, installation services, training services and a PCS service agreement, we recognize the CyberKnife system and installation services revenuefollowing installation and acceptance of the system by application of the residual method as prescribed in SOP No. 98-9 when VSOE of fair valueexists for all undelivered elements in the arrangement, including PCS.Other Revenue-Japan Upgrade Services Other revenue primarily consists of upgrade revenues related to the sale of specialized services specifically contracted to provide currenttechnology capabilities for units previously sold through a distributor into the Japan market. The upgrade programs include elements where VSOE offair value has not been established for the PCS. As a result, associated revenues are deferred and recognized ratably over the term of the PCSarrangement, generally four years.PCS and Maintenance Services Service revenue for providing PCS, which includes warranty services, extended warranty services, unspecified when and if available productupdates and technical support is deferred and recognized ratably over the service period, generally one year, until no further obligation exists. At thetime of sale, we provide for the estimated incremental costs of meeting product warranty if the incremental warranty costs are expected to exceed therelated service revenues. Training and consulting service revenues, that are not deemed essential to the functionality of the CyberKnife system, arerecognized as such services are performed.70 Costs associated with providing PCS and maintenance services are expensed when incurred, except when those costs are related to units whererevenue recognition has been deferred. In those cases, the costs are deferred until the recognition of the related revenue and are expensed over the periodof revenue recognition.Distributor Sales Sales to third party distributors are evidenced by distribution agreements governing the relationships together with binding purchase orders on atransaction-by-transaction basis. We record revenues from sales of CyberKnife systems to distributors based on a sell-through method where revenue isonly recognized upon shipment of the product to the end user customer and once all revenue recognition criteria are met including completion of all ourobligations under the terms of the purchase order. For sales of upgrades and accessories to distributors, revenue is recognized on either a sell-through orsell-in basis, depending upon the terms of the purchase order and once all revenue recognition criteria are met. These criteria require that persuasiveevidence of an arrangement exists, the fees are fixed or determinable, collection of the resulting receivable is probable and there is no right of return. Our agreements with customers and distributors generally do not contain product return rights. We assess the probability of collection based on a number of factors, including past transaction history with the customer and the credit-worthinessof the customer. We generally do not request collateral from our customers. If we determine that collection of a fee is not probable, we will defer the feeand recognize revenue upon receipt of cash.Shared Ownership Program We also enter into arrangements under our shared ownership program with certain customers. Under the terms of such program, we retain title toour CyberKnife system, while the customer has use of the product. We generally receive a minimum monthly payment and earn additional revenuesfrom the customer based upon their use of the product. We may provide unspecified upgrades to the product during the term of each program when andif available. Upfront, non-refundable payments from the customer are deferred and recognized as revenue over the contractual period. Revenues fromour shared ownership program are recorded as they become earned and receivable and are included within shared ownership program revenues in theconsolidated statements of operations. The CyberKnife systems associated with our shared ownership program are recorded within property and equipment and are depreciated over theirestimated useful life of ten years. Depreciation and warranty expense attributable to the CyberKnife shared ownership systems are recorded within costof our shared ownership program.Long-Term Manufacturing Contracts We also recognize revenue and cost of revenue related to long-term manufacturing contracts using contract accounting on the percentage-of-completion method in accordance with SOP No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Werecognize any loss provisions from the total contract in the period such loss is identified. During the years ended June 30, 2008, 2007, and 2006,contract revenue of $1.0 million, $0 and $0, respectively, was recorded in other revenue with related costs of $943,000, $0 and $0, respectively,recorded in cost of other revenue. As of June 30, 2008 and 2007, costs of $1.0 million and $323,000, respectively were recorded in deferred cost ofrevenue related to the contract manufacture of non-medical linacs.71Deferred Revenue and Deferred Cost of Revenue Deferred revenue consists of deferred product revenue, deferred shared ownership revenue, deferred service revenue and deferred other revenue.Deferred product revenue arises from the timing differences between the shipment of products and satisfaction of all revenue recognition criteriaconsistent with our revenue recognition policy. Deferred shared ownership revenue results from the receipt of advance payments of monthly minimumlease payments, which will be recognized ratably over the term of the shared ownership program. Deferred service revenue results from the advancepayment for services to be delivered over a period of time, usually one year. Service revenue is recognized ratably over the service period. Deferredother revenue results primarily from the Japan upgrade services programs and is due to timing difference between the receipt of cash payments for thoseupgrades and final delivery to the end user customer. Deferred cost of revenue consists of the direct costs associated with the manufacture of units,direct service costs and deferred costs associated with the Japan upgrade services for which the revenue has been deferred in accordance with ourrevenue recognition policies. Deferred revenue, and associated deferred cost of revenue, expected to be realized within one year are classified as currentliabilities and current assets, respectively.Stock-Based CompensationPrior to adoption of SFAS 123R Effective July 1, 2003, we began to account for stock-based employee compensation arrangements in accordance with SFAS 123 and SFAS 148.Under SFAS 123, stock-based compensation expense is measured on the date of grant based on the fair value of the award. Upon adoption of thisstandard, we elected to use the retrospective restatement method of transition. We believe that the fair value of the stock options is more reliably measurable than the fair value of the services received. We determined theestimated fair value of our common stock in light of the expected completion of its initial public offering. We engaged an unrelated third-party appraisalfirm to assist management in this process by providing a valuation analysis. The estimated fair value of stock options granted is calculated at the date ofgrant using the Black-Scholes option pricing model, as prescribed by SFAS 123, using fair values of common stock between $6.35 and $7.63 per shareand the following weighted-average assumptions during the year ended June 30, 2006: YearendedJune 30,2006 Risk-free interest rate 4.42%Dividend yield — Expected life 6.25 Expected volatility 86.7% In accordance with the requirements of SFAS 123, we recorded deferred stock-based compensation for the estimated fair value of the options onthe date of grant. This deferred stock-based compensation was amortized to expense over the period during which the options become exercisable,generally four years. During the year ended June 30, 2006, we reversed $1.7 million of deferred stock-based compensation related to cancellations ofunvested options of certain employees who had been granted stock options and subsequently terminated their employment with the Company. Duringthe year ended June 30, 2006, we amortized $7.9 million of stock-based compensation expense for stock options granted to employees. For certain stock option grants, we made modifications to the option terms. Those modifications included extensions of the vesting period andacceleration of vesting. The Company recognized $0, $072and $112,000 during the years ended June 30, 2008, 2007, and 2006, respectively, of stock-based compensation expense for modifications of stockoptions granted.Adoption of SFAS 123R Effective July 1, 2006, we adopted SFAS 123R using the modified prospective method under which compensation cost is recognized beginningwith the effective date (a) based on the requirements of SFAS 123R for all share-based payments granted or modified after the effective date and(b) based on the previous requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R that remain unvestedon the effective date. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cashflow, rather than as an operating cash flow as required under previous guidance. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary in subsequent periods if actual forfeitures differ frominitial estimates. Stock-based compensation expense was recorded net of estimated forfeitures for the years ended June 30, 2008 and 2007 such thatexpense was recorded only for those stock-based awards that are expected to vest. For the year ended June 30, 2007, we recorded a cumulative effect ofa change in accounting principle of $838,000, net of tax of $0, related to the adoption of SFAS 123R since we had previously adjusted stock-basedcompensation expense at the time forfeitures occurred in accordance with SFAS 123. The cumulative effect of this change in accounting reflectsestimated forfeitures related to periods prior to July 1, 2006. Under SFAS 123R, we estimated the fair value of each option award on the date of grant using the Black-Scholes option-pricing model using theassumptions noted in the table below. Expected volatility is based on the historical volatility of a peer group of publicly traded companies. The expectedterm of options is based upon the vesting term (i.e., 25% on the first anniversary of the vesting start date and 36 equal monthly installments thereafter)and on its partial life history. The risk-free rate for the expected term of the option is based on the U.S. Treasury Constant Maturity rate. During theyears ended June 30, 2008 and 2007, the estimated fair values of the stock options granted were calculated at each date of grant using the Black-Scholesoption pricing model, using fair values of common stock between $6.94 and $22.86 per share. Following our IPO, the fair value of our common stockis determined by its closing market price as published by the Nasdaq Global Market. During the years ended June 30, 2008 and 2007, we recognized$12.2 million and $10.5 million, respectively, of stock-based compensation expense for stock options granted to employees. The weighted-averageassumptions used to value options granted during the years ended June 30, 2008 and 2007 were as follows: Years ended June 30, 2008 2007 Risk-free interest rate 3.65% 4.89%Dividend yield — — Expected life 6.25 6.25 Expected volatility 60.3% 74.8% Stock-based compensation expense related to stock options granted to non-employees is recognized as the stock options are earned in accordancewith SFAS 123 and Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees forAcquiring, or in Conjunction with Selling, Goods or Services. We believe that the fair value of the stock options is more reliably measurable than thefair value of the services received. The estimated fair value of the stock options granted is calculated using the Black-Scholes option pricing model, asprescribed by SFAS 123, using fair values of common stock and weighted-average assumptions during the year of grant. We recognized $114,000,$171,000, and $186,000 during the years ended June 30, 2008, 2007, and 2006, respectively, of stock-based compensation expense for stock optionsgranted to non-employees.73 In January 2007, in connection with our IPO, the Board of Directors approved the 2007 Incentive Award Plan, or 2007 Plan, and the ESPP. TheESPP is deemed compensatory and compensation costs are accounted for under SFAS 123R. Under the ESPP, qualified employees are entitled to purchase common stock at 85% of the fair market value on specified dates. The estimated fairvalue of ESPP shares was calculated at the date of grant using the Black-Scholes option pricing model, using a fair value of common stock between$9.14 per share and $16.45 per share for the year ended June 30, 2008 and $18.00 per share for the year ended June 30, 2007. Expected volatility isbased on the historical volatility of a peer group of publicly traded companies. The expected term is based upon the offering period of the ESPP. Therisk-free rate for the expected term of the ESPP option is based on the U.S. Treasury Constant Maturity rate. For the years ended June 30, 2008 and2007, we recognized $1.0 million and $441,000 of compensation expense related to our ESPP, respectively. The following weighted-averageassumptions were used during the years ended June 30, 2008 and 2007: Years ended June 30, 2008 2007 Risk-free interest rate 3.07% 5.16%Dividend yield — — Expected life 0.50 0.75 Expected volatility 59.8% 49.9% In connection with the 2007 Plan, we issued restricted stock units, or RSU's, and recognized $4.0 million and $1.5 million of stock-basedcompensation expense, net of forfeitures for restricted stock units granted during the years ended June 30, 2008 and 2007, at a weighted-average grantdate fair value of $14.55 and $28.17, respectively. Excess tax benefits from tax deductions for exercised options and disqualifying dispositions, in excess of the deferred tax asset attributable to stockcompensation costs for such options are credited to additional paid-in-capital. Realized excess tax benefits for the years ended June 30, 2008 and 2007were $546,000 and $553,000, respectively. At June 30, 2008, $489,000 of capitalized stock-based compensation costs were included as components of inventory and deferred cost ofrevenue. No significant costs were capitalized at June 30, 2007.Inventories Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. Excess and obsolete inventories are written down based onhistorical sales and forecasted demand, as judged by management. We determine inventory and product costs, which include allocated productionoverheads, through use of standard costs which approximate actual average costs.Investments Our investments include short-term securities which include fixed-income securities, commercial paper, term notes and marketable debt securities.All investments are designated as available-for-sale and are therefore reported at fair value, with unrealized gains and losses recorded in accumulatedother comprehensive income. Realized gains and losses on the sale of investments are recorded in other income (expense). Investments with originalmaturities greater than approximately three months and remaining maturities less than one year are classified as short-term investments. Long-terminvestments include US corporate debt securities with maturities beyond one year and auction rate securities for which auctions were recentlyunsuccessful. We continue to hold these auction rate securities until a future auction for these investments is successful or a buyer is found outside ofthe74auction process, which may occur beyond one year. Short-term investments amounted to $85.5 million and none at June 30, 2008 and 2007,respectively. Long-term investments amounted to $37.0 million and none at June 30, 2008 and 2007, respectively. As of June 30, 2008, we held $21.5 million in interest bearing auction rate securities, or ARS, that represented investments in student loanobligations. These ARS investments are intended to provide liquidity via an auction process that resets the applicable interest rate at predeterminedcalendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. The recentuncertainties in the credit markets have affected all of our holdings in ARS investments and multiple auctions for these securities have beenunsuccessful. Consequently, the investments are not currently liquid and we may not be able to access these funds until a future auction of theseinvestments is successful or a buyer is found outside of the auction process. All of the ARS investments are "AAA" rated and were in compliance withour investment policy at the time of acquisition. We currently have the ability and intent to hold these ARS investments until a recovery of the auctionprocess or until maturity, which is generally greater than 12 months. As of June 30, 2008, the entire ARS investment balance is classified as long-terminvestments on our consolidated balance sheet because of our inability to determine when our investments in ARS would settle. In May 2008, wemodified our investment policy with the objective of increasing our investments in more liquid money market investments and to preclude any additionalexposure to auction rate securities. Typically the fair value of ARS investments approximates par value due to the frequent resets through the auction process. While we continue toearn interest on our ARS investments at the maximum contractual rate, these investments are not currently trading and therefore do not currently have areadily determinable market value. Accordingly, the estimated fair value of these investments no longer approximates par value. We have used a discounted cash flow model to determine the estimated fair value of our investment in ARS as of June 30, 2008. The assumptionsused in preparing the discounted cash flow model include estimates for interest rates, timing and amount of cash flows and expected holding periods ofthe ARS. Based on this assessment of fair value, as of June 30, 2008 we determined there was a temporary decline in the fair value of its ARSinvestments of $0.9 million, which is recorded in accumulated other comprehensive income (loss) in our consolidated balance sheet at that date. We review impairments in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and relatedguidance issued by the FASB and SEC in order to determine the classification of the impairment as "temporary" or "other-than-temporary." Atemporary impairment charge results in an unrealized loss being recorded in the other comprehensive income (loss) component of stockholders' equity.Such an unrealized loss does not affect net income (loss) for the applicable accounting period. An other-than-temporary impairment charge is recordedas a realized loss in the consolidated statement of operations and reduces net income (loss) for the applicable accounting period. In evaluating theimpairment of any individual ARS, we classified such impairment as temporary. If our assessment of the fair value in future periods is other thantemporary, we would record an impairment charge through our statement of operations.Provision for Income Taxes Estimates and significant management judgment are required in the calculation of certain tax liabilities and in the determination of the recoverabilityof certain deferred tax assets, which arise from temporary differences and carryforwards. Due to uncertainties related to our ability to realize ourdeferred tax assets, we record a valuation allowance equal to the amount of our net deferred tax assets. If we subsequently determine that it is morelikely than not we will be able to realize a portion or the full amount of deferred tax assets, we will record an adjustment to the deferred tax assetvaluation allowance as a credit to earnings in the period such determination is made.75Recent Accounting Pronouncements In April 2008, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position, or FSP, Statement of Financial AccountingStandards, or SFAS, 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developingrenewal or extension assumptions used to determine the useful life of intangible assets under SFAS 142, Goodwill and Other Intangible Assets. Theintent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of the expectedcash flows used to measure the fair value of the asset under SFAS 141 (revised 2007), Business Combinations and other U.S. generally acceptedaccounting principles. We have not yet determined the impact this standard will have on our consolidated financial statements. In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASBStatement No. 133, or SFAS 161. This Standard requires enhanced disclosures regarding derivatives and hedging activities, including: (a) the manner inwhich an entity uses derivative instruments; (b) the manner in which derivative instruments and related hedged items are accounted for under Statementof Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities;" and (c) the effect of derivativeinstruments and related hedged items on an entity's financial position, financial performance, and cash flows. SFAS 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15, 2008. We have not yet determined the impact this standard willhave on our consolidated financial statements. In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations, orSFAS 141R. SFAS 141R changes the accounting for acquisitions that close beginning in 2009. More transactions and events will qualify as businesscombinations and will be accounted for at fair value under the new standard. SFAS 141R promotes greater use of fair values in financial reporting.Some of the changes will introduce more volatility into earnings. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. Wehave not yet determined the impact this standard will have on our consolidated financial statements. In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51,or SFAS 160. SFAS 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, or ARB 51, to establish accounting andreporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement also amends certain ofARB 51's consolidation procedures for consistency with the requirements of SFAS 141R. In addition, SFAS 160 also includes expanded disclosurerequirements regarding the interests of the parent and its noncontrolling interest. The provisions of SFAS 160 are effective for fiscal years beginningafter December 15, 2008. Earlier adoption is prohibited. We have not yet determined the impact this standard will have on our consolidated financialstatements. In September 2006, the FASB issued SFAS 157. The standard defines fair value and provides a framework for using fair value to measure assetsand liabilities. SFAS 157 establishes the principle that fair value should consider characteristics specific to the asset or liability based on the assumptionsthat market participants would use when pricing the asset or liability. SFAS 157 is effective beginning in fiscal 2009, though early adoption ispermitted. In February 2008, the FASB issued FASB Staff Position, or FSP, 157-2, Effective Date of FASB Statement No. 157, or FSP 157-2.FSP 157-2 delays the effective date of SFAS No. 157 from fiscal 2009 to fiscal 2010 for all nonfinancial assets and nonfinancial liabilities, except thosethat are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of this standard on July 1,2008 did not have a significant impact on our consolidated financial statements. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including anamendment of FASB Statement No. 115, or SFAS 159, which allows an76entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities under an instrument-by-instrument election. Subsequent measurements for the financial assets and liabilities an entity elects to fair value will be recognized in earnings.SFAS 159 also establishes additional disclosure requirements. SFAS 159 is effective for fiscal years beginning after November 15, 2007, with earlyadoption permitted provided that the entity also adopts SFAS No. 157, "Fair Value Measurement", or SFAS 157. The adoption of this standard onJuly 1, 2008 did not have a significant impact on our consolidated financial statements.Item 7A. QUANTITATIVE & QUALITATIVE DISCLOSURE ABOUT MARKET RISK We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions ortransactions. For direct sales outside the United States it is likely we will sell in the local currency. For the year ended June 30, 2008, all of our executed salescontracts were denominated in U.S. dollars, with the exception of three sales contracts denominated in Euros. Future fluctuations in the value of theU.S. dollar may affect the price competitiveness of our products outside the United States. Some of our commissions related to sales of the CyberKnifesystem are payable in Euros. To the extent that management can predict the timing of payments under these contracts, we may engage in hedgingtransactions to mitigate such risks in the future. At June 30, 2008, we had $36.9 million of cash and cash equivalents and $122.6 million invested in other financial instruments. Our earnings areaffected by changes in interest rates due to the impact those changes have on interest income generated from our cash and investment balances. Webelieve that while the instruments we hold are subject to changes in the financial standing of the issuer of such securities, and except as described below,we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or othermarket changes that affect market risk sensitive instruments. However, should interest rates increase, the market value of our investments may decline,which could result in a realized loss if we are forced to sell before scheduled maturity. If overall interest rates had risen by 100 basis points, the fairvalue of our net investment position at June 30, 2008 would have decreased by approximately $610,000, assuming consistent levels. At June 30, 2008, we held approximately $21.5 million of ARS instruments whose underlying assets are student loans which are substantiallybacked by the federal government. In February 2008, auctions began to fail for these securities and each auction since then has failed. At June 30, 2008,we determined the fair market values of these securities using a discounted cash flow methodology. Significant inputs that went into the model wereestimates for interest rates, timing and amount of cash flows and the probability of the auction succeeding or the security being called. Changes in theassumptions of our model based on dynamic market conditions could have a significant impact on the valuation of these securities, which may lead us inthe future to take an impairment charge for these securities.77Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ACCURAY INCORPORATEDINDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageReport of Independent Registered Public Accounting Firm 79Consolidated Balance Sheets 80Consolidated Statements of Operations 81Consolidated Statement of Stockholders' Equity (Deficiency) 82Consolidated Statements of Cash Flows 83Notes to Consolidated Financial Statements 8478REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and StockholdersAccuray Incorporated We have audited the accompanying consolidated balance sheets of Accuray Incorporated and subsidiaries, the "Company", as of June 30, 2008and 2007, and the related consolidated statements of operations, stockholders' equity (deficiency), and cash flows for each of the three years in theperiod ended June 30, 2008. Our audits of the basic financial statements include the financial statement schedule listed in the index appearing underItem 15(b). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is toexpress an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. Anaudit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AccurayIncorporated and subsidiaries as of June 30, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in theperiod ended June 30, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, therelated financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein. As discussed in Note 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004), Share-Based Payment on a modified prospective basis as of July 1, 2006. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AccurayIncorporated's internal control over financial reporting as of June 30, 2008, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated September 5, 2008 expressed anadverse opinion thereon. /s/ GRANT THORNTON LLPSan Francisco, CaliforniaSeptember 5, 2008 79Accuray Incorporated Consolidated Balance Sheets (in thousands, except share and per share amounts) June 30, 2008 2007 Assets Current assets: Cash and cash equivalents $36,936 $204,830 Restricted cash 4,830 — Short-term investments 85,536 — Accounts receivable, net of allowance for doubtful accounts of $27 and $20 atJune 30, 2008 and 2007, respectively 33,918 10,105 Inventories 23,047 16,984 Prepaid expenses and other current assets 6,431 7,937 Deferred cost of revenue—current 31,667 30,709 Total current assets 222,365 270,565 Long-term investments 37,014 — Deferred cost of revenue—noncurrent 11,724 30,522 Property and equipment, net 17,140 23,937 Goodwill 4,495 4,495 Intangible assets, net 926 1,184 Other assets 1,340 1,406 Total assets $295,004 $332,109 Liabilities and stockholders' equity Current liabilities: Accounts payable $12,962 $14,147 Accrued compensation 7,504 13,127 Other accrued liabilities 4,369 4,113 Customer advances—current 22,331 12,634 Deferred revenue—current 87,455 78,022 Total current liabilities 134,621 122,043 Customer advances—noncurrent 2,900 8,388 Deferred revenue—noncurrent 26,720 76,235 Total liabilities 164,241 206,666 Commitments and contingencies (Note 7) Stockholders' equity Preferred stock, $0.001 par value; authorized: 5,000,000 shares; no shares issuedand outstanding — — Common stock, $0.001 par value; authorized: 100,000,000 shares; issued:56,719,864 and 53,798,643 shares at June 30, 2008 and 2007, respectively;outstanding: 54,579,846 and 53,798,643 shares at June 30, 2008 and 2007,respectively 55 53 Additional paid-in capital 252,901 251,637 Accumulated other comprehensive income (loss) (1,067) 10 Accumulated deficit (121,126) (126,257) Total stockholders' equity 130,763 125,443 Total liabilities and stockholders' equity $295,004 $332,109 Assets and liabilities include related party transaction amounts as follows: Deferred cost of revenue—current $11 $2,276 Deferred cost of revenue—noncurrent $— $4,817 Customer advances—noncurrent $— $5,251 Deferred revenue—current $231 $5,325  Deferred revenue—noncurrent $— $9,781 The accompanying notes are an integral part of these consolidated financial statements.80Accuray Incorporated Consolidated Statements of Operations (in thousands, except per share amounts) Years ended June 30, 2008 2007 2006 Net revenue: Products $152,374 $110,320 $36,089 Shared ownership program 10,262 10,090 8,145 Services 38,808 16,860 4,848 Other 8,937 3,182 3,815 Total net revenue 210,381 140,452 52,897 Cost of revenue: Cost of products 67,183 43,363 18,531 Cost of shared ownership program 2,517 2,637 2,513 Cost of services 26,865 12,269 3,948 Cost of other 6,864 2,144 2,500 Total cost of revenue 103,429 60,413 27,492 Gross profit 106,952 80,039 25,405 Operating expenses: Selling and marketing 42,726 37,889 25,186 Research and development 32,880 26,775 17,788 General and administrative 32,280 23,915 15,923 Total operating expenses 107,886 88,579 58,897 Loss from operations (934) (8,540) (33,492) Other income (expense): Interest and other income 7,841 4,261 503 Interest and other expense (657) (731) (447) Income (loss) before provision for income taxes and cumulative effect of changein accounting principle 6,250 (5,010) (33,436)Provision for income taxes 867 1,444 258 Income (loss) before cumulative effect of change in accounting principle 5,383 (6,454) (33,694)Cumulative effect of change in accounting principle, net of tax of $0 — 838 — Net income (loss) $5,383 $(5,616)$(33,694) Net income (loss) per share: Basic Income (loss) before cumulative effect of change in accounting principle $0.10 $(0.21)$(2.11) Cumulative effect of change in accounting principle — 0.03 — Basic net income (loss) per share $0.10 $(0.18)$(2.11) Diluted Income (loss) before cumulative effect of change in accounting principle $0.09 $(0.21)$(2.11) Cumulative effect of change in accounting principle — 0.03 — Diluted net income (loss) per share $0.09 $(0.18)$(2.11) Weighted average common shares outstanding used in computing net income(loss) per share: Basic 54,531 30,764 15,997 Diluted 60,434 30,764 15,997 Cost of revenue, selling and marketing, research and development, and generaland administrative expenses include stock-based compensation charges asfollows:  Cost of revenue $1,858 $1,205 $863 Selling and marketing $4,197 $3,958 $2,569 Research and development $3,059 $2,448 $1,574 General and administrative $7,785 $5,016 $3,237 Revenue and cost of revenue include related party transaction amounts asfollows: Net revenue: Products $— $3,694 $— Services $1,182 $2,597 $2,195 Other $787 $2,795 $3,754 Cost of revenue: Cost of products $59 $1,098 $— Cost of services $22 $1,029 $140 Cost of other $528 $2,144 $2,463 The accompanying notes are an integral part of these consolidated financial statements.81Accuray Incorporated Consolidated Statement of Stockholders' Equity (Deficiency) (in thousands, except share amounts) Common Stock NotesReceivablefromStockholder AccumulatedOtherComprehensiveIncome (Loss) AdditionalPaid-InCapital DeferredStock-BasedCompensation AccumulatedDeficit TotalStockholders'Equity(Deficiency) Shares Amount Balances at June 30, 2005 15,815,532 $12,653 $37,481 $(331)$(19,008)$(20)$(86,947)$(56,172)Exercise of common stock warrants 16,666 167 — — — — — 167 Exercise of stock options 431,659 538 — — — — — 538 Settlement of notes receivable — — — 125 — — — 125 Stock repurchased (20,707) (82) — — — — — (82)Deferred stock-based compensation — — 7,860 — (7,860) — — — Reversal of deferred stock-based compensation — — (1,651) — 1,651 — — — Amortization of deferred stock-based compensation — — — — 7,945 — — 7,945 Compensation expense related to options issued to non-employees — — 186 — — — — 186 Compensation expense related to modification of options granted — — 112 — — — — 112 Comprehensive loss: Net loss — — — — — — (33,694) (33,694) Cumulative translation adjustment — — — — — 20 — 20 Total comprehensive loss (33,674) Balances at June 30, 2006 16,243,150 13,276 43,988 (206) (17,272) — (120,641) (80,855)Conversion of redeemable preferred stock to common stock 25,186,285 25 27,479 — — — — 27,504 Conversion of common stock warrants 495,833 — — — — — — — Proceeds from initial public offering, net of expenses 10,399,997 10 170,555 — — — — 170,565 Reclassification of par value for Delaware reincorporation (13,260) 13,260 — — — — — Exercise of stock options, net 1,538,004 2 1,739 — — — — 1,741 Stock repurchased for settlement of notes receivable (64,626) — (454) 206 — — — (248)Reversal of deferred stock-based compensation upon adoption ofSFAS 123R — — (17,272) — 17,272 — — — Stock-based compensation — — 12,456 — — — — 12,456 Compensation expense related to options issued to non-employees — — 171 — — — — 171 Income tax benefits from employee stock plans — — 553 — — — — 553 Cumulative effect of change in accounting principle — — (838) — — — — (838) Comprehensive loss: Net loss — — — — — (5,616) (5,616) Cumulative translation adjustment — — — — — 10 — 10 Total comprehensive loss (5,606) Balances at June 30, 2007 53,798,643 53 251,637 — — 10 (126,257) 125,443 Exercise of stock options, net 2,564,269 3 4,352 — — — — 4,355 Issuance of common stock under employee stock purchase plan 265,349 1 2,957 — — — — 2,958 Issuance of restricted stock 91,603 — — — — — — — Stock-based compensation — — 17,274 — — — — 17,274 Stock repurchased for cash (2,140,018) (2) (23,979) — — — — (23,981)Compensation expense related to options issued to non-employees — — 114 — — — — 114 Income tax benefits from employee stock plans — — 546 — — — — 546 Adjustments to initially apply FIN 48 — — — — — — (252) (252) Comprehensive income: Net income — — — — — 5,383 5,383 Cumulative translation adjustment — — — — — (49) — (49) Unrealized loss on investments, net — — — — (1,028) — (1,028) Total comprehensive income 4,306 Balances at June 30, 2008 54,579,846 $55 $252,901 $— $— $(1,067)$(121,126)$130,763 The accompanying notes are an integral part of these consolidated financial statements.82Accuray Incorporated Consolidated Statements of Cash Flows (in thousands) Years ended June 30, 2008 2007 2006 Cash Flows From Operating Activities Net income (loss) $5,383 $(5,616)$(33,694)Adjustments to reconcile net income (loss) to net cash provided by (used in)operating activities: Depreciation and amortization 7,688 6,246 3,806 Stock-based compensation 16,899 12,627 8,243 Tax benefit from stock-based compensation 546 — — Excess tax benefit from stock-based compensation (419) — — Gain on investments (9) — — Provision for bad debts 30 2 (21) Loss on write-down of inventories 760 805 619 Loss on disposal of property and equipment 188 249 44 Accrued interest expense on note payable — — 103 Cumulative effect of change in accounting principle — (838) — Changes in assets and liabilities: Accounts receivable (23,920) (936) (6,590) Inventories (10,427) (8,770) (7,762) Prepaid expenses and other current assets 1,233 (5,061) (1,579) Deferred cost of revenue 26,208 (5,389) (20,112) Other assets 45 (146) (315) Accounts payable (1,180) 9,525 (707) Accrued liabilities (5,309) 3,125 9,423 Customer advances 4,283 (1,495) 10,946 Deferred revenue (39,988) 7,269 59,689 Net cash provided by (used in) operating activities (17,989) 11,597 22,091 Cash Flows From Investing Activities Purchases of property and equipment (5,030) (7,230) (10,188)Cash received for tenant improvements — — 1,000 Restricted cash (4,830) 1 157 Purchase of investments (177,651) (283) — Sale and maturity of investments 54,089 — — Net cash used in investing activities (133,422) (7,512) (9,031)Cash Flows From Financing Activities Payment of note payable — — (2,996)Proceeds from issuance of common stock 4,355 1,741 538 Proceeds from employee stock purchase plan 2,958 — — Payment received on notes used to exercise stock options — — 64 Stock repurchases (23,981) — (21)Proceeds from intial public offering, net of issuance costs — 170,565 — Excess tax benefit from stock-based compensation 419 553 — Exercise of common stock warrants — — 167 Net cash provided by (used in) financing activities (16,249) 172,859 (2,248)Effect of exchange rate changes on cash (234) 30 20 Net increase (decrease) in cash and cash equivalents (167,894) 176,974 10,832 Cash and cash equivalents at beginning of period 204,830 27,856 17,024 Cash and cash equivalents at end of period $36,936 $204,830 $27,856 Supplemental Disclosure of Cash Flow Information Cash paid for interest $223 $— $196 Income taxes paid $1,264 $138 $183 Non-cash Investing and Financing Activities Stock repurchased for settlement of notes receivable $— $206 $— Cashless stock repurchases and options exercised $— $— $122 Cash flows include related party transaction amounts as follows: Accounts receivable $— $(1)$439 Deferred cost of revenue $7,082 $3,080 $2,248 Customer advances $(5,251)$(990)$5,241 Deferred revenue $(14,875)$(6,723)$(1,059)The accompanying notes are an integral part of these consolidated financial statements.83Accuray Incorporated Notes to Consolidated Financial Statements 1. Description of BusinessOrganization Accuray Incorporated (the "Company") was incorporated in California in December 1990 and commenced operations in January 1992. TheCompany designs, develops and sells the CyberKnife system, an image-guided robotic radiosurgery system used for the treatment of solid tumorsanywhere in the body. The Company has formed eight wholly owned subsidiaries: Accuray International SARL, located in Geneva, Switzerland, Accuray Europe SARL,located in Paris, France, Accuray UK Ltd, located in London, United Kingdom, Accuray Asia Limited, located in Hong Kong, SAR, Japan AccurayKK, located in Tokyo, Japan, Accuray Spain, S.L.U, located in Madrid, Spain, Accuray Medical Equipment (India) Private Ltd., located in New Delhi,India and Accuray Medical Equipment (SEA) Private Limited, located in Singapore. The purpose of these subsidiaries is to market the Company'sproducts in the various countries in which they are located.Initial Public Offering In February 2007, the Company completed its initial public offering ("IPO") of common stock in which a total of 18,399,998 shares were sold andissued, including 8,000,000 shares sold by selling stockholders, at an issue price of $18.00 per share. The Company raised a total of $187.2 million ingross proceeds from the IPO, or approximately $170.6 million in net proceeds after deducting underwriting discounts and commissions of$13.1 million and other offering costs of approximately $3.5 million. Upon the closing of the IPO, all shares of convertible preferred stock outstandingand warrants outstanding automatically converted into 25,186,285 and 495,833 shares of common stock, respectively.2. Summary of Significant Accounting PoliciesFiscal Year On October 1, 2006, the Company prospectively changed its fiscal calendar to a 52- or 53- week period. The Company's fiscal year ends on theSaturday closest to June 30th, so that in a 52 week period, each fiscal quarter consists of 13 weeks. The additional week in a 53-week year is added tothe fourth quarter, making such quarter consist of 14 weeks. Fiscal years 2008, 2007 and 2006 are each comprised of 52 weeks. For ease ofpresentation purposes, the consolidated financial statements and notes refer to June 30 as the Company's fiscal year end.Basis of Presentation and Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company transactions andbalances have been eliminated in consolidation. Certain prior period balances have been reclassified to conform to current period presentation.Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements. Key estimates and assumptions made by the Company relate to stock-84Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)based compensation, valuation allowances for deferred tax assets, valuation of excess and obsolete inventories, impairment of long-lived assets andgoodwill, deferred revenue and deferred cost of revenue. Actual results could differ from those estimates.Foreign Currency The Company's international subsidiaries use their local currencies as their functional currencies. For those subsidiaries, assets and liabilities aretranslated at exchange rates in effect at the balance sheet date and income and expense accounts at average exchange rates during the year. Resultingtranslation adjustments are recorded directly to accumulated comprehensive income (loss) within the statement of stockholders' equity (deficiency).Foreign currency transaction gains and losses are included as a component of other income (expense).Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash equivalentsconsist of amounts invested in highly liquid investment accounts and money market accounts and amounted to $30.7 million and $191.4 million atJune 30, 2008 and 2007, respectively. Cash and cash equivalent balances denominated in a foreign currency amounted to $1.0 million and $2.1 millionat June 30, 2008 and 2007, respectively.Restricted Cash Restricted cash includes amounts deposited as collateral per the terms of contracts with customers requiring that deposited cash amounts be securedvia letters of credit until delivery of the CyberKnife unit occurs. Restricted cash amounts were $4.8 million and $0 at June 30, 2008 and 2007,respectively.Investments The Company's investments include fixed-income securities, commercial paper, term notes and marketable debt securities. All investments aredesignated as available-for-sale and are therefore reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensiveincome (loss). Realized gains and losses on the sale of investments are recorded in other income (expense). The cost of securities sold is based on thespecific identification method. Investments with original maturities greater than approximately three months and remaining maturities less than one yearare classified as short-term investments. Long-term investments include US corporate debt securities with maturities beyond one year and auction ratesecurities for which recent auctions were unsuccessful. The Company continues to hold these auction rate securities until a future auction for theseinvestments is successful or a buyer is found outside of the auction process, which may occur beyond one year. Short-term investments amounted to$85.5 million and none at June 30, 2008 and 2007, respectively. Long-term investments amounted to $37.0 million and none at June 30, 2008 and2007, respectively.Fair Value of Financial Instruments The carrying values of the Company's financial instruments including cash and cash equivalents, restricted cash, accounts receivable and accountspayable are approximately equal to their respective fair values due to the relatively short-term nature of these instruments.85Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)Concentration of Credit Risk and Other Risks and Uncertainties The Company's cash and cash equivalents are mainly deposited with three major financial institutions. At times, deposits in these institutionsexceed the amount of insurance provided on such deposits. The Company has not experienced any losses in such accounts and believes that it is notexposed to any significant risk on these balances. The following summarizes revenues from customers in excess of 10% of total net revenue: Years ended June 30, 2008 2007 2006 Meditec/Marubeni Corporation (related party in 2006) — — 11% The following summarizes the accounts receivable from customers in excess of 10% of total accounts receivable: June 30, 2008 2007 Customer A 10% — Customer B 11% — Customer C — 36%Customer D 23% 14%Customer E — 11% Accounts receivable are typically not collateralized. The Company performs ongoing credit evaluations of its customers and maintains reserves forpotential credit losses. Accounts receivable are deemed past due in accordance with the contractual terms of the agreement. Accounts are charged againstthe allowance for doubtful accounts once collection efforts are unsuccessful. Historically, such losses have been within management's expectations. TheCompany's allowance for doubtful accounts was $27,000 and $20,000 at June 30, 2008 and 2007, respectively. The Company is subject to risks common to companies in the medical device industry including, but not limited to: new technological innovations,dependence on key personnel, dependence on key suppliers, protection of proprietary technology, compliance with government regulations, uncertaintyabout widespread market acceptance of products and potential product liability. The Company's products include components subject to rapidtechnological change. Certain components used in manufacturing have relatively few alternative sources of supply and establishing additional orreplacement suppliers for such components cannot be accomplished quickly. While the Company has ongoing programs to minimize the adverse effectof such uncertainty and considers technological change in estimating its allowances, uncertainty continues to exist. The products currently under development by the Company may require clearance by the U.S. Food and Drug Administration ("FDA") or otherinternational regulatory agencies prior to commercial sales. There can be no assurance that the Company's products will receive the necessary clearance.Denial or delay of such clearance could have a material adverse impact on the Company.86Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)Inventories Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. Excess and obsolete inventories are written down based onhistorical sales and forecasted demand, as judged by management. The Company determines inventory and product costs, which include allocatedproduction overheads, through use of standard costs which approximate actual average costs.Revenue Recognition The Company earns revenue from the sale of products, the operation of its shared ownership program, and the provision of related services, whichinclude installation services, post-contract customer support ("PCS"), training and consulting. The Company's products and upgrades to those productsinclude software that is essential to the functionality of the products and accordingly, the Company accounts for sales of its products pursuant toStatement of Position ("SOP") No. 97-2, Software Revenue Recognition ("SOP 97-2"), as amended. The Company recognizes product revenues for sales of the CyberKnife system, upgrades, components and replacement parts and accessories whenthere is persuasive evidence of an arrangement, the fee is fixed or determinable, collection of the fee is probable and delivery has occurred as prescribedby SOP 97-2. Payments received in advance of product shipment are recorded as customer advances and are recognized as revenue or deferred revenueupon product shipment or installation. For arrangements with multiple elements, the Company allocates arrangement consideration to each element based upon vendor specific objectiveevidence ("VSOE") of fair value of the respective elements. VSOE of fair value for each element is based upon the Company's standard rates chargedfor the product or service when such product or service is sold separately or based upon the price established by management having the relevantauthority when that product or service is not yet being sold separately. When contracts contain multiple elements, and VSOE of fair value exists for allundelivered elements, the Company accounts for the delivered elements, principally the CyberKnife system, based upon the "residual method" asprescribed by SOP No. 98-9, Modification of SOP No. 97-2 with Respect to Certain Transactions ("SOP 98-9"). If VSOE of fair value does not existfor all the undelivered elements, all revenue is deferred until the earlier of; (1) delivery of all elements, or (2) establishment of VSOE of fair value for allremaining undelivered elements.CyberKnife sales with legacy service plans For sales of CyberKnife systems with PCS arrangements that include specified or committed upgrades for which the Company has not establishedVSOE of fair value, all revenue is deferred and accounted for as described above. Once all such upgrade obligations have been delivered, allaccumulated and deferred revenue is recognized ratably over the remaining life of the PCS arrangement. Sales of additional upgrades as optional extras prior to the delivery of all originally specified upgrade obligations are considered additionalelements of the original arrangement and associated revenues are deferred and accounted for as described above. Sales of additional upgrades afterdelivery of all specified upgrade obligations, as stated in the original contract, are recognized once all revenue recognition criteria applicable to thosearrangements are met.87Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)CyberKnife sales with nonlegacy service plans In fiscal year 2006, the Company began selling CyberKnife systems with PCS contracts that only provide for upgrades when and if they becomeavailable. The Company has established VSOE of the fair value of PCS in these circumstances. For arrangements with multiple elements that includethe CyberKnife system, installation services, training services and a PCS service agreement, the Company recognizes the CyberKnife system andinstallation services revenue following installation and acceptance of the system by application of the residual method as prescribed in SOP 98-9 whenVSOE of fair value exists for all undelivered elements in the arrangement, including PCS.Other revenue—Japan upgrade services Other revenue primarily consists of upgrade services revenues related to the sale of specialized services specifically contracted to provide currenttechnology capabilities for units previously sold through a distributor into the Japan market. Some upgrade sales include elements where VSOE of fairvalue has not been established for the PCS. As a result, for these sales, associated revenues are deferred and recognized ratably over the term of thePCS arrangement, generally four years.PCS and maintenance services Service revenue for providing PCS, which includes warranty services, extended warranty services, unspecified when and if available productupgrades and technical support is deferred and recognized ratably over the service period, generally one year, until no further obligation exists. At thetime of sale, the Company provides for the estimated incremental costs of meeting product warranty if the incremental warranty costs are expected toexceed the related service revenues. Training and consulting service revenues that are not deemed essential to the functionality of the CyberKnifesystem, are recognized as such services are performed. Costs associated with providing PCS and maintenance services are expensed when incurred, except when those costs are related to units whererevenue recognition has been deferred. In those cases, the costs are deferred until the recognition of the related revenue and are recognized over theperiod of revenue recognition.Distributor sales Sales to third party distributors are evidenced by a distribution agreement governing the relationship together with binding purchase orders on atransaction-by-transaction basis. The Company records revenues from sales of CyberKnife systems to distributors based on a sell-through methodwhere revenue is only recognized upon shipment of the product to the end user customer and once all other revenue recognition criteria are metincluding completion of all obligations under the terms of the purchase order. For sales of upgrades and accessories to distributors, revenue isrecognized on either a sell-through or sell-in basis, depending upon the terms of the purchase order and once all revenue recognition criteria are met.These criteria require that persuasive evidence of an arrangement exist, the fees are fixed or determinable, collection of the resulting receivable isprobable and there is no right of return. The Company's agreements with customers and distributors generally do not contain product return rights.88Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued) The Company assesses the probability of collection based on a number of factors, including past transaction history with the customer and thecredit-worthiness of the customer. The Company generally does not request collateral from its customers. If the Company determines that collection of afee is not probable, the Company will defer the fee and recognize revenue upon receipt of cash.Shared ownership program The Company also enters into arrangements under its shared ownership program with certain customers. Agreements under the shared ownershipprogram typically have a term of five years, during which the customer has the option to purchase the system, either at the end of the contractual periodor in advance, at the customer's request, at pre-determined prices. Under the terms of such program, the Company retains title to its CyberKnife system,while the customer has use of the product. The Company generally receives a minimum monthly payment and earns additional revenues from thecustomer based upon its use of the product. The Company may provide unspecified upgrades to the product during the term of each program when andif available. Upfront non-refundable payments from the customer are deferred and recognized as revenue over the contractual period. Revenues from theshared ownership program are recorded as they become earned and receivable and are included within shared ownership program revenues in theconsolidated statements of operations. The Company recognized $10.3 million, $10.1 million and $8.1 million for the years ended June 30, 2008, 2007and 2006, respectively, of revenue from the shared ownership program. Future minimum revenues under the shared ownership arrangements as of June 30, 2008 are as follows (in thousands):Years ending June 30, 2009 $480 2010 480 2011 480 2012 480 2013 and thereafter 240 Total $2,160 Total usage-based fee revenues, included in shared ownership program revenue, earned from the CyberKnife systems operated under the sharedownership program amounted to $8.1 million, $7.5 million and $6.1 million for the years ended June 30, 2008, 2007, and 2006, respectively. Under the terms of the shared ownership program, the customer has the option to purchase the CyberKnife system at pre-determined prices basedon the period the system has been in use and considering the lease payments already received. Revenue from such sales is recorded in accordance withthe Company's revenue recognition policy, taking into account the PCS and any other elements that might be sold as part of the arrangement. AtJune 30, 2008, the Company had three systems installed under its shared ownership program. During the years ended June 30, 2008 and 2007,$23.7 million and $3.0 million, respectively, of total revenue was recognized in the consolidated statements of operations for the sale of 12 and oneCyberKnife system units, respectively, that were formerly under the shared ownership program. At June 30, 2008 and 2007, $2.3 million and $50,000,respectively, of amounts for extended warranty and training services related to these sold shared89Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)ownership units remained recorded as deferred revenue, and will be recognized over the life of the extended warranty service period and as trainingservice obligations are fulfilled. There were no sales of shared ownership systems during the year ended June 30, 2006. The CyberKnife systems associated with the Company's shared ownership program are recorded within property and equipment and aredepreciated over their estimated useful life of ten years. Depreciation and warranty expenses attributable to the CyberKnife shared ownership systemsare recorded within cost of shared ownership program.Long-term manufacturing contracts The Company recognizes revenue and cost of revenue related to long-term manufacturing contracts using contract accounting on the percentage-of-completion method in accordance with SOP No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts,("SOP 81-1"). The Company recognizes any loss provisions from the total contract in the period such loss is identified. During the years endedJune 30, 2008, 2007, and 2006, contract revenue of $1.0 million, $0 and $0, respectively, was recorded in other revenue with related costs of $943,000,$0 and $0, respectively, recorded in cost of other revenue. As of June 30, 2008 and 2007, costs of $1.0 million and $323,000, repectively, wererecorded in deferred cost of revenue related to the manufacture of non-medical linacs.Deferred Revenue and Deferred Cost of Revenue Deferred revenue consists of deferred product revenue, deferred shared ownership program revenue, deferred service revenue and deferred otherrevenue. Deferred product revenue arises from timing differences between the shipment of product and satisfaction of all revenue recognition criteriaconsistent with the Company's revenue recognition policy. Deferred shared ownership program revenue results from the receipt of advance paymentsthat will be recognized ratably over the term of the shared ownership program. Deferred service revenue results from the advance payment for servicesto be delivered over a period of time, usually one year. Service revenue is recognized ratably over the service period. Deferred other revenue resultsprimarily from the Japan upgrade services programs and is due to timing differences between the receipt of cash payments for those upgrades and finaldelivery to the end user customer. Deferred cost of revenue consists of the direct costs associated with the manufacturing of units, direct service costsfor which the revenue has been deferred in accordance with the Company's revenue recognition policies, and deferred costs associated with the Japanupgrade services. Deferred revenue, and associated deferred cost of revenue, expected to be realized within one year are classified as current liabilitiesand current assets, respectively.Customer Advances Customer advances represent payments made by customers in advance of product shipment.Property and Equipment Property and equipment are recorded at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-linemethod over the estimated useful lives of the related assets. Leasehold improvements are amortized on a straight-line basis over the life of the lease orthe estimated useful life of the asset, whichever is shorter. Machinery and equipment are depreciated over90Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)five years. Furniture and fixtures are depreciated over four years. Computer and office equipment are depreciated over three years. CyberKnife systemscovered by the shared ownership program are depreciated over their estimated useful life of ten years. Repairs and maintenance costs, which are notconsidered improvements and do not extend the useful life of the property and equipment, are expensed as incurred. The cost and related accumulateddepreciation of property and equipment sold or no longer in service are eliminated from the accounts and any gain or loss is recognized.Impairment of Long-Lived Assets In accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment or Disposalof Long-lived Assets, ("SFAS 144") the Company reviews long-lived assets, including property and equipment, for impairment whenever events orchanges in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Under SFAS 144, an impairment losswould be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less thanits carrying amount. Impairment, if any, is measured as the amount by which the carrying value of a long-lived asset exceeds its fair value. ThroughJune 30, 2008, there have been no such impairment losses.Goodwill and Purchased Intangible Assets Goodwill represents the excess of acquisition cost over the fair value of tangible and identified intangible net assets of businesses acquired.Goodwill is not amortized, but is tested for impairment on an annual basis and between annual tests in certain circumstances, and written down whenimpaired. Purchased intangible assets other than goodwill are amortized over their useful lives unless their lives are determined to be indefinite.Purchased intangible assets are carried at cost, less accumulated amortization. Amortization is computed over the estimated useful lives of the respectiveassets which is typically seven years.Shipping and Handling The Company's shipping and handling costs billed to customers are included in product revenue. Shipping and handling costs incurred areincluded in cost of products.Software Development Costs Software development costs are included in research and development and are expensed as incurred. After technological feasibility is established,material software development costs are capitalized. The capitalized cost is then amortized on a straight-line basis over the estimated product life, or onthe ratio of current revenues to total projected product revenue, whichever is greater. To date, the period between achieving technological feasibility,which the Company has defined as the establishment of a working model which typically occurs when the beta testing commences, and the generalavailability of such software has been short and software development costs qualifying for capitalization have been insignificant.91Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)Advertising Expenses The Company expenses the costs of advertising and promoting its products and services as incurred. Advertising expenses were approximately$1.0 million, $1.0 million and $20,000, for the years ended June 30, 2008, 2007 and 2006, respectively.Research and Development Costs Costs related to research, design and development of products are charged to research and development expense as incurred. These costs includedirect salary costs for research and development personnel, costs for materials used in research and development activities, costs for outside servicesand allocated portions of facilities and other corporate costs. The Company has entered into research and clinical study arrangements with selectedhospitals, cancer treatment centers, academic institutions and research institutions worldwide. These agreements support the Company's internal researchand development capabilities.Stock-Based CompensationPrior to adoption of SFAS 123R Effective July 1, 2003, the Company began to account for stock-based employee compensation arrangements in accordance with SFAS No. 123,Accounting for Stock-Based Compensation ("SFAS 123"), and SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure("SFAS 148"). Under SFAS 123, stock-based compensation expense was measured on the date of grant based on the fair value of the award. Uponadoption of this standard, the Company elected to use the retrospective restatement method of transition. The Company believed that the fair value of the stock options was more reliably measurable than the fair value of the services received. TheCompany determined the estimated fair value of its common stock prior to its IPO with the help of an unrelated third-party appraisal firm that provided avaluation analysis. The estimated fair value of stock options granted was calculated at the date of grant using the Black-Scholes option pricing model, asprescribed by SFAS 123, using fair values of common stock between $6.35 and $7.63 per share and the following weighted-average assumptionsduring the year ended June 30, 2006: YearendedJune 30,2006 Risk-free interest rate 4.42%Dividend yield — Expected life 6.25 Expected volatility 86.7% In accordance with the requirements of SFAS 123, the Company recorded deferred stock-based compensation for the estimated fair value of theoptions on the date of grant. This deferred stock-based compensation was amortized to expense over the period during which the options becameexercisable, generally four years. During the year ended June 30, 2006, the Company reversed $1.7 million of deferred stock-based compensationrelated to forfeitures of unvested options of certain employees who had been granted stock options and subsequently terminated their employment withthe92Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)Company. During the year ended June 30, 2006, the Company amortized $7.9 million of stock-based compensation expense for stock options grantedto employees. For certain stock option grants, the Company made modifications to the option terms. Those modifications included extensions of the vestingperiod and the acceleration of vesting. The Company recognized $0, $0 and $112,000 during the years ended June 30, 2008, 2007 and 2006,respectively, of stock-based compensation expense for modifications of stock options granted.Adoption of SFAS 123R Effective July 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95("SFAS 123R") using the modified prospective method under which compensation cost is recognized beginning with the effective date (a) based on therequirements of SFAS 123R for all share-based payments granted or modified after the effective date and (b) based on the previous requirements ofSFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R that remained unvested on the effective date. SFAS 123R alsorequires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cashflow as required under previous guidance. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary in subsequent periods if actual forfeitures differ frominitial estimates. Stock-based compensation expense was recorded net of estimated forfeitures for the years ended June 30, 2008 and 2007 such thatexpense was recorded only for those stock-based awards that were expected to vest. For the year ended June 30, 2007, the Company recorded acumulative effect of a change in accounting principle of $838,000, net of tax of $0, related to the adoption of SFAS 123R since it had previouslyadjusted stock-based compensation expense at the time forfeitures occurred in accordance with SFAS 123. The cumulative effect of this change inaccounting reflects estimated forfeitures related to periods prior to July 1, 2006. Under SFAS 123R, the Company estimated the fair value of each option award on the date of grant using the Black-Scholes option-pricing modelusing the assumptions noted in the table below. Expected volatility was based on the historical volatility of a peer group of publicly traded companies.The expected term of options was based upon the vesting term (for example, 25% on the first anniversary of the vesting start date and 36 equal monthlyinstallments thereafter) and on its partial life history. The risk-free rate for the expected term of the option was based on the U.S. Treasury ConstantMaturity rate. During the years ended June 30, 2008 and 2007, the estimated fair values of the stock options granted were calculated at each date of grant usingthe Black-Scholes option pricing model, using fair values of common stock between $6.94 and $22.86 per share, and $12.88 and $29.25 per share,respectively. Following its IPO, the fair value of the Company's common stock was determined by its closing market price as published by the NasdaqGlobal Market. During the years ended June 30, 2008 and 2007, the Company recognized $12.2 million and $10.5 million, respectively, of stock-based93Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)compensation expense for stock options granted to employees. The weighted-average assumptions used to value options granted during the years endedJune 30, 2008 and 2007 were as follows: Years endedJune 30, 2008 2007 Risk-free interest rate 3.65% 4.89%Dividend yield — — Expected life 6.25 6.25 Expected volatility 60.3% 74.8% Stock-based compensation expense related to stock options granted to non-employees is recognized as the stock options are earned in accordancewith SFAS 123 and Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees forAcquiring, or in Conjunction with Selling, Goods or Services. The Company believes that the fair value of the stock options is more reliably measurablethan the fair value of the services received. The estimated fair value of the stock options granted is calculated using the Black-Scholes option pricingmodel, as prescribed by SFAS 123, using fair values of common stock and weighted-average assumptions as the grant vests. The Company recognized$114,000, $171,000 and $186,000 during the years ended June 30, 2008, 2007 and 2006, respectively, of stock-based compensation expense for stockoptions granted to non-employees. In January 2007, in connection with the Company's IPO, the Board of Directors approved the 2007 Incentive Award Plan ("2007 Plan") and 2007Employee Stock Purchase Plan ("ESPP"). The ESPP is deemed compensatory and compensation costs are accounted for under SFAS 123R. Under the ESPP, qualified employees are entitled to purchase common stock at 85% of the fair market value on specified dates. The estimated fairvalue of ESPP shares was calculated at the date of grant using the Black-Scholes option pricing model, using a fair value of common stock between$9.14 per share and $16.45 per share for the year ended June 30, 2008 and $18.00 per share for the year ended June 30, 2007. Expected volatility wasbased on the historical volatility of a peer group of publicly traded companies. The expected term was based upon the offering period of the ESPP. Therisk-free rate for the expected term of the ESPP option was based on the U.S. Treasury Constant Maturity rate. For the years ended June 30, 2008 and2007, the Company recognized $1.0 million and $441,000 of compensation expense related to its ESPP, respectively. The following weighted-averageassumptions were used during the years ended June 30, 2008 and 2007: Years endedJune 30, 2008 2007 Risk-free interest rate 3.07% 5.16%Dividend yield — — Expected life 0.50 0.75 Expected volatility 59.8% 49.9%94Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued) In connection with the 2007 Plan, the Company issued restricted stock units, ("RSU's") and recognized $4.0 million and $1.5 million of stock-based compensation expense, net of estimated forfeitures, for RSU's granted during the years ended June 30, 2008 and 2007, at a weighted-averagegrant date fair value of $14.55 and $28.17, respectively. Tax benefits from tax deductions for exercised options and disqualifying dispositions in excess of the deferred tax asset attributable to stockcompensation costs for such options are credited to additional paid-in capital. Realized excess tax benefits for the years ended June 30, 2008, 2007 and2006 were $546,000, $553,000 and $0, respectively. At June 30, 2008, $489,000 of capitalized stock-based compensation costs were included as components of inventory and deferred cost ofrevenue. No significant costs were capitalized at June 30, 2007.Net Income (Loss) Per Common Share Basic net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of common shares outstandingduring the period. Diluted net income (loss) per share is computed by dividing net income (loss) by the weighted-average number of dilutive commonshares outstanding during the period. Dilutive shares outstanding are calculated by adding to the weighted shares outstanding any common stockequivalents from outstanding stock options and warrants based on the treasury stock method. In periods when net income is reported, the calculation ofdiluted net income per share typically results in lower earnings per share than is calculated using the basic method. In periods when a net loss isreported, potential shares from stock options and warrants are not included in the calculation because they would have an anti-dilutive effect, meaningthe loss per share would be reduced. Therefore, in periods when a loss is reported, the calculation of basic and diluted net loss per share results in thesame value. For the years ended June 30, 2008, 2007 and 2006, the basic net income (loss) per share amounts were based on weighted-average shares of54,530,650, 30,764,447 and 15,997,419, respectively. For the years ended June 30, 2008, 2007 and 2006, the diluted net income (loss) per shareamounts were based on weighted-average shares of 60,434,263, 30,764,447 and 15,997,419, respectively. The number of anti-dilutive shares excludedfrom the calculation of diluted net income (loss) per share was as follows: Years ended June 30, 2008 2007 2006 Preferred stock (as if converted) — 15,318,782 25,186,285 Options to purchase common stock 1,993,964 10,791,875 10,900,285 Restricted stock units 669,449 648,330 — Warrants — — 451,353 2,663,413 26,758,987 36,537,923 95Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued) The following table sets forth the basic and diluted per share computations: Years ended June 30, 2008 2007 2006 Numerator: Net income (loss) (in thousands) $5,383 $(5,616)$(33,694)Denominator: Basic weighted-average shares outstanding 54,530,650 30,764,447 15,997,419 Stock options and restricted stock units 5,903,613 — — Diluted weighted-average shares of common stock outstanding 60,434,263 30,764,447 15,997,419 Basic net income (loss) per share: $0.10 $(0.18)$(2.11) Diluted net income (loss) per share: $0.09 $(0.18)$(2.11) Income Taxes The Company is required to estimate its income taxes in each of the tax jurisdictions in which it operates prior to the completion and filing of taxreturns for such periods. This process involves estimating actual current tax expense together with assessing temporary differences in the treatment ofitems for tax purposes versus financial accounting purposes that may create net deferred tax assets and liabilities. The Company accounts for incometaxes under the asset and liability method, which requires, among other things, that deferred income taxes be provided for temporary differencesbetween the tax bases of the Company's assets and liabilities and their financial statement reported amounts. In addition, deferred tax assets are recordedfor the future benefit of utilizing net operating losses, research and development credit carry forwards and temporary differences. The Company records a valuation allowance to reduce its deferred tax assets to the amount the Company believes is more likely than not to berealized. Because of the uncertainty of the realization of the deferred tax assets, the Company has recorded a full valuation allowance against its domesticand foreign net deferred tax assets. In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, Accounting for Uncertainty in IncomeTaxes ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance withSFAS No. 109, Accounting for Income Taxes ("FAS 109"), and prescribes a recognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken in a tax return. The Company adopted the provisions of FIN 48 effectiveJuly 1, 2007. As a result of the implementation of FIN 48, the Company recognized a tax reserve for uncertain tax positions of $252,000, which was accountedfor as a reduction to the July 1, 2007 balance of retained earnings. Furthermore, the Company had $1.4 million of unrecognized tax benefits, all ofwhich would affect its income tax expense if recognized. The unrecognized tax benefits mainly relate to federal and state net operating losses andresearch tax credits. In the year ended June 30, 2008, approximately $128,000 of related tax reserves were released. The Company files income taxreturns in96Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)the US federal jurisdiction, and various states and foreign jurisdictions. Due to attributes being carried forward, the statute of limitations remains openfor the US federal jurisdiction and domestic states for tax years from 1999 forward. The statute of limitations in France remains open from 2005 andHong Kong remains open from 2002. In accordance with FIN 48, the Company classifies interest and penalties as a component of tax expense. Such interest and penalties wereimmaterial as of June 30, 2008. The Company adopted the provisions of Emerging Issues Task Force ("EITF") Issue No. 06-03, How Taxes Collected from Customers andRemitted to Government Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation), effective January 1, 2007.EITF No. 06-03 allows companies to choose either the gross basis or net basis of income statement presentation for taxes collected from customers andremitted to governmental authorities and requiries companies to disclose such policy. The Company applies the net basis presentation for taxes collectedfrom customers and remitted to government authorities.Comprehensive Income (Loss) Comprehensive income (loss) includes net income (loss), foreign currency translation adjustments and unrealized gains and losses on investmentsthat have been excluded from the determination of net income (loss). The Company has reported the components of comprehensive income (loss) in itsconsolidated statement of stockholders' equity.Segment Information The Company has determined that it operates in only one segment in accordance with SFAS No. 131, Disclosures About Segments of anEnterprise and Related Information ("SFAS 131") as it only reports profit and loss information on an aggregate basis to its chief operating decisionmaker. The Company's long-lived assets maintained outside the United States are not material. Revenue by geographic region is based on the shipping addresses of the Company's customers. The following summarizes revenue by geographicregion (in thousands): Years ended June 30, 2008 2007 2006 United States (including Puerto Rico) $142,557 $91,174 $40,826 Europe 10,138 30,175 3,390 Asia (excluding Japan) 40,770 13,797 3,058 Japan 16,916 5,306 5,623 Total $210,381 $140,452 $52,897 Recent Accounting Pronouncements In April 2008, the FASB issued FASB Staff Position ("FSP") SFAS 142-3, Determination of the Useful Life of Intangible Assets, which amendsthe factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets underSFAS 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the97Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued)useful life of a recognized intangible asset under SFAS 142 and the period of the expected cash flows used to measure the fair value of the asset underSFAS 141 (revised 2007), Business Combinations and other U.S. generally accepted accounting principles. The Company has not yet determined theimpact this standard will have on its financial statements. In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASBStatement No. 133 ("SFAS 161"). This Standard requires enhanced disclosures regarding derivatives and hedging activities, including: (a) the mannerin which an entity uses derivative instruments; (b) the manner in which derivative instruments and related hedged items are accounted for underSFAS No. 133, Accounting for Derivative Instruments and Hedging Activities; and (c) the effect of derivative instruments and related hedged items onan entity's financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interimperiods beginning after November 15, 2008. The Company has not yet determined the impact this standard will have on its financial statements. In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations ("SFAS 141R"). SFAS 141R changes theaccounting for acquisitions that close beginning in 2009. More transactions and events may qualify as business combinations and will be accounted forat fair value under the new standard. SFAS 141R promotes greater use of fair values in financial reporting. Some of the changes may introduce morevolatility into earnings. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. The Company has not yet determined theimpact this standard will have on its financial statements. In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements—An Amendment of ARB No. 51("SFAS 160"). SFAS 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements ("ARB 51"), to establish accounting andreporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement also amends certain ofARB 51's consolidation procedures for consistency with the requirements of SFAS 141R. In addition, SFAS 160 also includes expanded disclosurerequirements regarding the interests of the parent and its noncontrolling interest. The provisions of SFAS 160 are effective for fiscal years beginningafter December 15, 2008. Earlier adoption is prohibited. The Company has not yet determined the impact this standard will have on its consolidatedfinancial statements. In September 2006, the FASB issued SFAS 157, Fair Value Measurement ("SFAS 157"). The standard defines fair value and provides aframework for using fair value to measure assets and liabilities. SFAS 157 establishes the principle that fair value should consider characteristicsspecific to the asset or liability based on the assumptions that market participants would use when pricing the asset or liability. SFAS 157 is effective forthe Company beginning in fiscal 2009, though early adoption is permitted. The Company has not yet determined the impact this standard will have onits financial statements. In February 2008, the FASB issued FASB Staff Position ("FSP") 157-2, Effective Date of FASB Statement No. 157("FSP 157-2"). FSP 157-2 delays the effective date of SFAS No. 157 from fiscal 2009 to fiscal 2010 for all nonfinancial assets and nonfinancialliabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption ofthis standard on July 1, 2008 did not have a significant impact on the Company's financial statements.98Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)2. Summary of Significant Accounting Policies (Continued) In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including anamendment of FASB Statement No. 115 ("SFAS 159"), which allows an entity the irrevocable option to elect fair value for the initial and subsequentmeasurement for certain financial assets and liabilities under an instrument-by-instrument election. Subsequent measurements for the financial assets andliabilities an entity elects to measure at fair value will be recognized in earnings. SFAS 159 also establishes additional disclosure requirements.SFAS 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted provided that the entity also adopts SFASNo. 157. The adoption of this standard on July 1, 2008 did not have a significant impact on the Company's financial statements.3. Available-For-Sale Securities Investments in marketable securities classified as available-for-sale by security type at June 30, 2008 consisted of the following (in thousands): AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses Fair Value Short-term investments: Commercial paper $41,541 $11 $(17)$41,535 US Corporate debt 11,371 9 (41) 11,339 Government-sponsored enterprises 32,665 22 (25) 32,662 Total short-term investments $85,577 $42 $(83)$85,536 Long-term investments: US Corporate debt $3,503 $— $(28)$3,475 Government-sponsored enterprises 12,098 — (68) 12,030 Auction rate securities 22,400 — (891) 21,509 Total long-term investments $38,001 $— $(987)$37,014 Total short and long-term investments $123,578 $42 $(1,070)$122,550 The Company did not have any investments in marketable securities at June 30, 2007. During the year ended June 30, 2008, the Company realizedgains on the sale of publicly-held equity securities of approximately $9,000. Contractual maturities of investments at June 30, 2008 consisted of the following (in thousands): AmortizedCost Fair Value Mature in less than one year $85,577 $85,536 Mature in one to three years 15,601 15,505 Mature after three years 22,400 21,509 Total $123,578 $122,550 Securities with no single maturity date include publicly traded equity securities, mortgage-and asset-backed securities99Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)3. Available-For-Sale Securities (Continued) As of June 30, 2008, the Company held $21.5 million in interest bearing auction rate securities ("ARS") that represented investments in studentloan obligations. These ARS investments are intended to provide liquidity via an auction process that resets the applicable interest rate at predeterminedcalendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. The recentuncertainties in the credit markets have affected all of the Company's holdings in ARS investments and multiple auctions for these securities have beenunsuccessful. Consequently, the investments were not currently liquid and the Company may not be able to access these funds until a future auction ofthese investments is successful or a buyer is found outside of the auction process. All of the ARS investments were "AAA" rated and were incompliance with the Company's investment policy at the time of acquisition. At June 30, 2008, the Company had the ability and intent to hold theseARS investments until a recovery of the auction process or until maturity, which is generally greater than 12 months. The Company reclassified theentire ARS investment balance from short-term investments to long-term investments on its balance sheet because of the Company's inability todetermine when its investments in ARS would settle. In May 2008, the Company modified its investment policy to preclude any additional exposure toauction rate securities. Typically the fair value of ARS investments approximates par value due to the frequent resets through the auction process. While the Companycontinued to earn interest on its ARS investments at the maximum contractual rate, these investments were not currently trading at June 30, 2008.Accordingly, the estimated fair value of these investments no longer approximated par value at that date. The Company has used a discounted cash flow model to determine the estimated fair value of its investment in ARS as of June 30, 2008. Theassumptions used in preparing the discounted cash flow model included estimates for interest rates, timing and amount of cash flows and expectedholding periods of the ARS. Based on this assessment of fair value, as of June 30, 2008 the Company determined there was a temporary decline in thefair value of its ARS investments of $891,000, which is recorded in accumulated other comprehensive income at June 30, 2008. The Company reviews its investment impairments in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and EquitySecurities, and related guidance issued by the FASB and SEC in order to determine the classification of the impairment as "temporary" or "other-than-temporary." A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income (loss) component ofstockholders' equity. Such an unrealized loss does not affect net income (loss) for the applicable accounting period. An other-than-temporaryimpairment charge is recorded as a realized loss in the statement of operations and reduces net income (loss) for the applicable accounting period. Inevaluating the impairment of any individual ARS, the Company classified such impairment as temporary. If the Company's assessment of the fair valuein future periods is other than temporary, the Company will record an impairment charge through its statement of operations. The Company regularly reviews its investment portfolio to identify and evaluate investments that have indications of possible impairment. Factorsconsidered in determining whether a loss is temporary include: the length of time and extent to which fair market value has been lower than the costbasis, the financial condition and near-term prospects of the investee, credit quality, and the Company's ability to hold the investment for a period of timesufficient to allow for any anticipated recovery in fair market value. Generally, the contractual terms of the investments do not permit settlement at pricesless than the amortized cost of the investments. The Company has determined that the gross unrealized100Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)3. Available-For-Sale Securities (Continued)losses related to investments at June 30, 2008 are temporary in nature. The gross unrealized losses related to investments are primarily due to failedauctions on the Company's auction rate securities and to a decrease in the fair market value of fixed-rate debt securities as a result of increases in interestrates. All of the Company's investments with continuous unrealized losses have been in an unrealized loss position for less than twelve months atJune 30, 2008.4. Balance Sheet ComponentsAccounts Receivable, net Accounts receivable, net consisted of the following (in thousands): June 30, 2008 2007 Accounts receivable $33,264 $9,267 Unbilled fees and services 681 858 33,945 10,125 Less: Allowance for doubtful accounts (27) (20) Accounts receivable, net $33,918 $10,105 Inventories Inventories consisted of the following (in thousands): June 30, 2008 2007 Raw materials $8,853 $9,776 Work-in-process 3,967 2,525 Finished goods 10,227 4,683 Total inventories $23,047 $16,984 101Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)4. Balance Sheet Components (Continued)Property and Equipment, net Property and equipment consisted of the following (in thousands): June 30, 2008 2007 Furniture and fixtures $3,379 $1,605 Computer and office equipment 6,912 5,529 Leasehold improvements 7,579 7,387 Machinery and equipment 12,287 9,747 CyberKnife shared ownership systems 3,951 12,393 34,108 36,661 Less: Accumulated depreciation and amortization (16,968) (12,724) Property and equipment, net $17,140 $23,937 Depreciation and amortization expense related to property and equipment for the years ended June 30, 2008, 2007 and 2006 was $7.4 million,$6.0 million and $3.6 million, respectively. Accumulated depreciation related to the CyberKnife systems attributable to the shared ownership program atJune 30, 2008 and 2007 was $1.6 million and $3.3 million, respectively.5. Goodwill and Other Purchased Intangibles In accordance with SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), goodwill and other intangible assets with indefinite livesare not amortized. Intangible assets with determinable useful lives are amortized on a straight line basis over their useful lives. Goodwill and otherintangible assets resulted from the Company's January 2005 acquisition of the High Energy Systems Division ("HES") of American Science andEngineering, Inc. ("AS&E"). The Company integrated this operation into its existing manufacturing operation. HES had been the sole sourcemanufacturer of the linear accelerator used in the CyberKnife system. SFAS 142 requires that the Company perform an annual test for impairment ofintangible assets with indefinite lives, and interim tests if indications of potential impairment exist. The Company performed the annual test forimpairment in December 2007 concluding that there was no impairment of goodwill. At June 30, 2008, there had been no indicators to perform aninterim test. The amortization expense relating to intangible assets for the years ending June 30, 2008, 2007 and 2006 was $258,000, $262,000 and$242,000, respectively. The following represents the gross carrying amounts and accumulated amortization of amortized intangible assets at June 30,2008 and 2007, respectively (in thousands): June 30, 2008 2007 Complete technology $1,740 $1,740 Customer contract/relationship 70 70 1,810 1,810 Less: Accumulated amortization (884) (626) Intangible assets, net $926 $1,184 102Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)5. Goodwill and Other Purchased Intangibles (Continued) The following table represents the estimated useful life of the intangible assets subject to amortization: Years Amortized intangible assets: Complete technology 7.0 Customer contract / relationship 7.0 The estimated future amortization expense of purchased intangible assets as of June 30, 2008, is as follows (in thousands):Years ending June 30, 2009 $259 2010 259 2011 259 2012 149 Total $926 6. Service Plan Contracts Service contract revenue for providing parts, warranty, product upgrades and customer support is deferred and recognized ratably over thecontractual service period, generally one year, until no further obligation exists. Deferred service contract revenue included in deferred revenue was (in thousands):Balance at June 30, 2005 $12,320 Additional deferred revenue 20,419 Less revenue recognized (3,635) Balance at June 30, 2006 29,104 Additional deferred revenue 26,572 Less revenue recognized (14,596) Balance at June 30, 2007 41,080 Additional deferred revenue 37,934 Less revenue recognized (34,001) Balance at June 30, 2008 $45,013 Costs incurred under service contracts included in cost of revenue were $24.0 million, $9.7 million and $2.4 million during the years endedJune 30, 2008, 2007 and 2006, respectively.7. Commitments and ContingenciesOperating Lease Agreements The Company leases office space under non-cancelable operating leases with various expiration dates through December 2011. Rent expense,including common area maintenance, was $4.9 million,103Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)7. Commitments and Contingencies (Continued)$2.4 million and $2.0 million for the years ended June 30, 2008, 2007 and 2006, respectively. Sublease income was $161,000, $165,000 and $0 for theyears ended June 30, 2008, 2007 and 2006, respectively. The terms of the facility leases provide for rental payments on a graduated scale. TheCompany recognizes rent expense on a straight-line basis over the lease period, and has accrued for rent expense incurred but not paid. Future minimum lease payments under non-cancelable operating lease agreements as of June 30, 2008 were as follows (in thousands): Operatingleases Subleaseincome Total Years ending June 30, 2009 $4,875 $(218)$4,657 2010 3,093 (224) 2,869 2011 770 (57) 713 2012 371 — 371 2013 and thereafter 41 — 41 Total $9,150 $(499)$8,651 The Company enters into standard indemnification agreements with its landlords and all superior mortgagees and their respective directors,officers' agents, and employees in the ordinary course of business. Pursuant to these agreements, the Company will indemnify, hold harmless, and agreeto reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally the landlords, in connection with any loss,accident, injury, or damage by any third party with respect to the leased facilities. The term of these indemnification agreements is from thecommencement of the lease agreements until termination of the lease agreements. The maximum potential amount of future payments the Companycould be required to make under these indemnification agreements is unlimited; however, historically the Company has not incurred claims or costs todefend lawsuits or settle claims related to these indemnification agreements.Royalty Agreements The Company entered into a license and royalty agreement with Schonberg Research Corporation ("Schonberg") in January 1991 in exchange foran exclusive license to use certain technology. Under the terms of the agreement, as amended in April 1996, the Company was obligated to paySchonberg $25,000 for each CyberKnife system sold that includes the licensed technology. Maximum total aggregate payments under this licenseagreement were $2,500,000. Royalty expense recognized in cost of revenue or deferred cost of revenue sold under this agreement was $0, $169,000and $850,000 during the years ended June 30, 2008, 2007 and 2006, respectively. This agreement expired in November 2006. In July 1997, the Company entered into a license and royalty agreement with Stanford University ("Stanford") under which the Company has anon-exclusive license to use certain technology. Under this agreement, the Company is obligated to pay Stanford up to $10,000 for each CyberKnifesystem sold that includes the licensed technology, with the stipulation that the Company must make minimum annual payments of $25,000. Royaltyexpense recorded in cost of revenue or deferred cost of revenue was $155,000, $195,000 and $175,000 for the years ended June 30, 2008, 2007 and2006, respectively. At104Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)7. Commitments and Contingencies (Continued)June 30, 2008 and 2007, the Company had accrued amounts of approximately $40,000 and $45,000, respectively, included in other accrued liabilities inthe consolidated balance sheets relating to this license and royalty agreement. In January 1999, the Company entered into a license and royalty agreement with Professor Dr. Achim Schweikard ("Schweikard") of theUniversity of Munich. Under this agreement, the Company has a non-exclusive license to use certain technology. The Company is obligated to paySchweikard up to $5,000 for each CyberKnife system sold that includes the licensed technology, with the stipulation that the Company must makeminimum annual payments of $5,000. Royalty expense under this agreement recorded in cost of revenue or deferred cost of revenue was $160,000,$165,000 and $120,000 for the years ended June 30, 2008, 2007 and 2006, respectively. At June 30, 2008 and 2007, the Company had accruedamounts of approximately $40,000 and $45,000, respectively, included in other accrued liabilities in the consolidated balance sheets relating to thislicense and royalty agreement. In March 2007, the Company entered into a license and royalty agreement with Deutsches Krebsforschungszentrum ("DKFZ"), a German cancerresearch center. Under this agreement, the Company has a non-exclusive license to use certain technology. The Company is obligated to pay DKFZ$12,500 for each CyberKnife system sold that includes the licensed technology, with the stipulation that the Company must make minimum annualpayments of $50,000. Royalty expense under this agreement recorded in cost of revenue or deferred cost of revenue was $54,000, $0 and $0 for theyears ended June 30, 2008, 2007 and 2006, respectively. At June 30, 2008 and 2007, the Company had accrued amounts of approximately $38,000 and$0, respectively, included in other accrued liabilities in the consolidated balance sheets relating to this license and royalty agreement.Contingencies From time to time, the Company may become involved in litigation relating to claims arising from the ordinary course of business. Managementdoes not believe the final disposition of these matters will have a material adverse effect on the financial position, results of operations or future cashflows of the Company.Software License Indemnity Under the terms of the Company's software license agreements with its customers, the Company agrees that in the event the software soldinfringes upon any patent, copyright, trademark, or any other proprietary right of a third party, it will indemnify its customer licensees, against any loss,expense, or liability from any damages that may be awarded against its customer. The Company includes this infringement indemnification in all of itssoftware license agreements and selected managed services arrangements. In the event the customer cannot use the software or service due toinfringement and the Company cannot obtain the right to use, replace or modify the license or service in a commercially feasible manner so that it nolonger infringes, then the Company may terminate the license and provide the customer a refund of the fees paid by the customer for the infringinglicense or service. The Company has recorded no liability associated with this indemnification, as it is not aware of any pending or threatened actionsthat are probable losses.105Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)8. Stockholders' Equity (Deficiency)Common Stock In February 2007, the Company completed its IPO of common stock in which a total of 18,399,998 shares were sold and issued, including8,000,000 shares sold by selling stockholders at an issue price of $18.00 per share. The Company raised a total of $187.2 million in gross proceedsfrom the IPO, or approximately $170.6 million in net proceeds after deducting underwriting discounts and commissions of $13.1 million and estimatedother offering costs of approximately $3.5 million. Upon the closing of the IPO, all shares of convertible preferred stock outstanding and warrantsoutstanding automatically converted into 25,186,285 and 495,833 shares of common stock, respectively. As of June 30, 2007, the Company's Amended and Restated Certificate of Incorporation authorized the Company to issue 100,000,000 shares ofcommon stock. As of June 30, 2008 and 2007, there were 56,719,864 and 53,798,643 shares of common stock issued and 54,579,846 and 53,798,643shares of common stock outstanding, respectively. In August 2007 the Company announced that the Board of Directors had approved a stock repurchase plan that authorized the Company torepurchase shares of its common stock. Under the plan, the Company has the ability to acquire up to $25.0 million of common shares in the openmarket over a period of one year. As of June 30, 2008, the Company had repurchased 2,140,018 shares of its common stock for $24.0 million. Suchshares were not retired nor returned to the status of authorized, unissued shares. Accordingly, such shares remain issued and classified as treasury stockas of June 30, 2008. The Company accounts for its treasury stock under the par value method. At June 30, 2008, the par value of the Company'streasury stock was immaterial. In October 2006, the Company repurchased 64,626 shares of common stock from a stockholder and former employee of the Company. Proceedsfrom the repurchase totaling $454,000 were used to settle two notes receivable from the stockholder of $206,000 and $227,000 and the related accruedinterest on the notes.Stock Option Plans In 1993, the Company's stockholders approved the 1993 Stock Option Plan (the "1993 Plan"). Under the 1993 Plan, the Board of Directors isauthorized to grant options to purchase up to 1,744,268 shares of common stock at fair value, as determined by the Board of Directors, to employees,directors and consultants. In 1998, the Company's stockholders approved the 1998 Equity Incentive Plan (the "1998 Plan"). Under the 1998 Plan, the Board of Directors isauthorized to grant options to purchase up to 14,100,000 shares of common stock to employees, directors and consultants. In 2007, in connection with the Company's IPO, the Board of Directors approved the 2007 Incentive Award Plan (the "2007 Plan"). Under the2007 Plan, the Board of Directors is authorized to award stock-based grants to employees, directors, and consultants for up to 4,500,000 shares. As ofJune 30, 2007, the 1993 Plan and the 1998 Plan continued to remain in effect along with the 2007 Plan; however, options can no longer be granted fromthe 1993 and 1998 Plans. Only employees are eligible to receive incentive stock options. Non-employees may be granted non-qualified options. The Board of Directors hasthe authority to set the exercise price of all options granted, subject to the exercise price of incentive stock options being no less than 100% of the fair106Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)8. Stockholders' Equity (Deficiency) (Continued)value of a share of common stock on the date of grant; and no less than 85% of the fair value for non-qualified stock options. Generally, the Company's outstanding options vest at a rate of 25% per year. However, certain options granted to certain employees vest, andexpense is recognized, based upon performance. Continued vesting typically terminates when the employment or consulting relationship ends. The maximum term of the options granted to persons who own at least 10% of the voting rights of all outstanding stock on the date of grant is5 years. The maximum term of all other options is 10 years. The options outstanding and exercisable, by exercise price, at June 30, 2008 were as follows: Options Outstanding Options Exercisable Exercise Price Number ofOptions WeightedAverageRemainingContractualLife (Years) WeightedAverageExercisePrice Number ofOptions WeightedAverageExercisePrice $0.75 2,515,684 3.82 $0.75 2,515,684 $0.75 $0.85–$2.50 1,079,956 5.89 $1.99 1,060,458 $1.98 $3.00 23,000 2.38 $3.00 23,000 $3.00 $3.50 1,756,149 6.57 $3.50 1,481,630 $3.50 $3.75–$6.73 1,026,752 7.19 $4.82 696,803 $4.73 $7.81–$9.52 1,011,227 8.29 $9.33 389,155 $9.44 $9.56–$13.83 1,026,481 8.66 $11.74 243.049 $10.69 $15.22–$23.11 493,969 9.29 $16.86 39,628 $17.21 $24.14 97,500 8.91 $24.14 28,281 $24.14 $28.47 182,113 8.69 $28.47 88,832 $28.47 9,212,831 6.43 $5.70 6,566,520 $3.46 The aggregate intrinsic value in the table below represents the total pretax intrinsic value (the difference between the fair value of the Company'scommon stock on June 30, 2008 of $7.46 and the exercise price of the options) that would have been received by option holders if all options exercisedhad been exercised on June 30, 2008. The total intrinsic value of options exercised in the years ended June 30, 2008, 2007 and 2006 was approximately$29.2 million, $26.3 million and $2.5 million, respectively. Cash received from option exercises for the years ended June 30, 2008 and 2007 were$4.4 million and $1.7 million, respectively. Cash received from option and warrant exercises for the year ended June 30, 2006 was $705,000.107Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)8. Stockholders' Equity (Deficiency) (Continued) Option activity during the year ended June 30, 2008 was as follows: Optionsoutstanding Weightedaverageexerciseprice Weightedaverageremainingcontractuallife (years) Aggregateintrinsicvalue as ofJune 30, 2008 Balance at June 30, 2007 10,791,875 $3.79 Options granted 1,220,930 $14.17 Options forfeited (235,466)$5.71 Options exercised (2,564,508)$1.70 Balance at June 30, 2008 9,212,831 $5.70 6.43 $32,561,844 Vested or Expected to vest at June 30,2008 8,997,584 $5.55 6.38 $32,475,057 Exercisable at June 30, 2008 6,566,520 $3.46 5.66 $30,563,269 As of June 30, 2008, there was approximately $23.9 million, net of estimated forfeitures, of unrecognized compensation cost related to unvestedstock options which is expected to be recognized over a weighted-average period of 2.29 years. The Company's current practice is to issue new sharesto satisfy share option exercises. The total fair value of shares vested during the years ended June 30, 2008, 2007 and 2006 was $14.3 million,$9.5 million and $8.4 million, respectively. The weighted average fair value of options granted was $8.14, $11.40 and $5.53 per share for the years ended June 30, 2008, 2007 and 2006,respectively.Restricted Stock Units Restricted stock units granted generally vest at a rate of 25% per year. However, certain RSU's granted vest 10% upon the first anniversary year ofthe grant date, 20% upon the second anniversary year of the grant date, 30% upon the third anniversary year of the grant date and 40% upon the fourthanniversary year of the grant date. Compensation charges for such graded RSU's are recognized using the straight-line method. Continued vestingtypically terminates when the employment relationship ends. As of June 30, 2008, there was approximately $16.6 million of unrecognized compensation cost related to RSU's, which is expected to berecognized over a weighted-average period of 2.76 years.108Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)8. Stockholders' Equity (Deficiency) (Continued) Combined activity under the 1993 Plan, 1998 Plan and 2007 Plan (the "Plans") was as follows: SharesAvailableFor Grant Number ofOptions WeightedAverageExercisePrice Number ofRSUs WeightedAverageGrantDateFairValue Balance at June 30, 2005 90,782 10,497,394 $1.67 — $— Additional shares reserved 2,900,000 — $— — $— Grants (1,407,883) 1,407,883 $4.80 — $— Forfeitures 573,333 (573,333)$2.15 — $— Exercises or releases — (431,659)$1.25 — $— Balance at June 30, 2006 2,156,232 10,900,285 $2.07 — $— Additional shares reserved 4,500,000 — $— — $— Plan shares expired (987,662) — $— — $— Grants (2,440,289) 1,775,774 $12.50 664,515 $28.17 Forfeitures 360,500 (344,315)$5.93 (16,185)$28.47 Exercises or releases — (1,539,869)$1.14 — $— Balance at June 30, 2007 3,588,781 10,791,875 $3.79 648,330 $28.16 Plan shares expired (209,829) — $— — $— Grants (1,481,830) 1,220,930 $14.17 260,900 $14.55 Forfeitures 329,059 (235,466)$5.71 (93,593)$27.58 Exercises or releases — (2,564,508)$1.70 (91,603)$10.90 Balance at June 30, 2008 2,226,181 9,212,831 $5.70 724,034 $23.43 Employee Stock Purchase Plan Under the ESPP, the Company is authorized to issue up to 1,000,000 shares of common stock. Qualified employees may purchase shares ofcommon stock through payroll deductions at a price per share that is 85% of the lesser of the fair market value of the Company's common stock as ofthe beginning of an applicable offering period or the applicable purchase date, with purchases generally occurring every six months. Employees' payrolldeductions may not exceed 10% of their salary. Employees may purchase up to 2,500 shares per period provided that the value of the shares purchasedin any calendar year may not exceed $25,000, as calculated pursuant to the purchase plan. The ESPP was initiated in February 2007. As of June 30, 2008, there was approximately $460,000 of unrecognized compensation cost related tothe ESPP, which is expected to be recognized over a weighted-average period of 0.4 years. The weighted-average fair value of ESPP shares was $5.68and $6.94 per share for the years ended June 30, 2008 and 2007, respectively.Warrants In August 2002, in connection with the renegotiation of a contractual commitment with a distributor, the Company issued a warrant to purchase525,000 shares of common stock at an exercise price of $1.00 per share. Using the Black-Scholes option pricing model, the Company estimated that thefair value of the warrant was $225,000 on the date of issue and recorded the warrant in additional109Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)8. Stockholders' Equity (Deficiency) (Continued)paid in capital. In February 2007, these warrants were exercised as a cashless exercise in which 495,833 shares of common stock were issued inconnection with the Company's IPO. In connection with the Series B preferred stock financing in April 2001, the Company was obligated to issue up to 333,333 warrants to purchasecommon stock at a price per share of $10.00, based on the Company not meeting certain deadlines relating to an initial public offering of the Company'scommon stock. Using the Black-Scholes option pricing model, the Company estimated the fair value of the warrants to be $373,000 based on thefollowing assumptions: fair value of a share of common stock equal to $3.00; term of 5 years; exercise price of $10.00; volatility of 75.0%; dividendrate of 0% and risk-free interest rate of 5.34%. The estimated fair value of the warrants was credited to additional paid-in capital with a correspondingdebit to Series B preferred stock. During November 2005, warrants to purchase 16,666 shares of common stock were exercised, and the remaining316,667 warrants expired unexercised in April 2006.9. Income Taxes For financial reporting purposes, "Income (loss) before provision for income taxes" included the following components (in thousands): June 30, 2008 2007 2006 Domestic $5,910 $(4,919)$(33,120)Foreign 340 747 (316) Total worldwide $6,250 $(4,172)$(33,436) The provision for income taxes consisted of the following (in thousands): Years ended June 30, 2008 2007 2006 Current: Federal $367 $558 $134 State 180 508 54 Foreign 244 378 70 Total current 791 1,444 258 Deferred: Federal — — — State — — — Foreign 76 — — Total deferred 76 — — Total provision $867 $1,444 $258 110Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)9. Income Taxes (Continued) A reconciliation of income taxes at the statutory federal income tax rate to net income taxes included in the accompanying consolidated statementsof operations is as follows (in thousands): Years ended June 30, 2008 2007 2006 U.S. federal taxes (benefit): At federal statutory rate $2,168 $(1,672)$(11,304) State tax, net of federal benefit 180 (218) (1,571) Stock-based compensation expense 1,209 2,311 1,894 Change in valuation allowance (2,251) 1,912 11,277 Credits (1,592) (1,402) (437) Federal alternative minimum tax 367 558 134 Other 467 (423) 195 Foreign 319 378 70 Total $867 $1,444 $258 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financialreporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets at June 30, 2008 and2007 were as follows (in thousands): June 30, 2008 2007 Deferred tax assets: Federal and state net operating losses $38 $4,205 Accrued vacation 853 964 Deferred revenue 22,769 27,108 Credits 6,062 4,457 Capitalized research and development 340 409 Stock-based compensation expense 8,030 4,511 Reserves not deductible for tax purposes 3,104 2,201 Other 1,711 1,268 Total deferred tax assets 42,907 45,123 Deferred tax liabilities: Fixed assets (525) (404) Total deferred tax liabilities (525) (404)Valuation allowance (42,382) (44,719) Net deferred tax assets: $— $— As of June 30, 2008, the Company had approximately $23.8 million and $16.5 million in federal and state net operating loss carryforwards,respectively, which expire in varying amounts beginning in 2019 for federal purposes and 2013 for state purposes. Such net operating losscarryforwards included excess tax benefits from employee stock option exercises which, in accordance with SFAS 123R, had not111Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)9. Income Taxes (Continued)been recorded in the Company's deferred tax assets. The Company will record approximately $9.2 million as a credit to additional paid in capital as andwhen such excess benefits are ultimately realized. In addition, as of June 30, 2008, the Company had federal and state research and development tax credits of approximately $3.9 million and$4.8 million, respectively. The federal research credits will begin to expire in 2025 and the state research credits have no expiration date. Based on the available objective evidence and history of losses, the Company has established a 100% valuation allowance against its domestic andforeign net deferred tax assets due to the uncertainty surrounding the realization of such assets. In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, Accounting for IncomeTaxes ("FAS 109"), and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. The Company adopted the provisions of FIN 48 effective July 1, 2007. Under FIN 48, the impact of an uncertain income tax position on income tax expense must be recognized at the largest amount that is more-likely-than-not to be sustained. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Upon review ofthe Company's reserves, the Company recognized a tax reserve for uncertain tax positions of $252,000 which was accounted for as a reduction to theJuly 1, 2007 balance of retained earnings. At the adoption date of July 1, 2007, the Company estimated that it had $4.8 million of unrecognized taxbenefits, all of which would affect its income tax expense if recognized. Based on an analysis performed during the year the opening July 1, 2007balance was reduced by approximately $3.5 million. This adjustment related to deferred tax assets which carried a full valuation allowance; therefore,there was no impact on the financial statements. Material changes in unrecognized tax benefits for the year ended June 30, 2008 total $3.4 million. The following is a roll forward of the Company's gross unrecognized tax benefit and liabilities associated with its uncertain tax positions for theyear ended June 30, 2008 (in thousands):Balance at July 1, 2007 $4,800 Revisions to opening unrecognized tax benefits (3,467)Tax positions related to current year: Additions 291 Reductions — Tax positions related to prior years: Additions — Reductions (244)Settlements — Lapses in statutes of limitations — Balance at June 30, 2008 $1,380 112Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)9. Income Taxes (Continued) The calculation of unrecognized tax benefits involves dealing with uncertainties in the application of complex global tax regulations. Managementregularly assesses the Company's tax positions in light of legislative, bilateral tax treaty, regulatory and judicial developments in the countries in whichthe Company does business. Management does not believe there will be any material changes in the unrecognized tax benefits within the next12 months. The Company's continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. Such interest andpenalties were immaterial as of June 30, 2008. The Company files income tax returns in the United States, various states and foreign jurisdictions. Due to attributes being carried forward, thestatute of limitations remains open for the US federal jurisdiction and domestic states for tax years from 1999 and forward. The statute of limitations inFrance remains open from 2005, and Hong Kong remains open from 2002.10. Other Income (Expense) For the years ended June 30, 2008, 2007 and 2006, other income (expense) consisted of the following (in thousands): Years ended June 30, 2008 2007 2006 Interest income $7,679 $4,261 $501 Foreign currrency transaction gain 153 — — Realized gain on investments 9 — — Other — — 2 Total interest and other income $7,841 $4,261 $503 Years ended June 30, 2008 2007 2006 Interest expense $(173)$(157)$(324)Foreign currrency transaction loss — (131) (21)Loss on asset disposition (188) (249) (44)State sales and local taxes (295) (194) (23)Other (1) — (35) Total interest and other expense $(657)$(731)$(447) 11. Related Party Transactions The Company recognized related party revenue of $734,000, $3.8 million and $195,000, during the years ended June 30, 2008, 2007 and 2006,respectively, relating to products and services provided to Stanford. The Company's former Chief Executive Officer, Dr. John R. Adler, Jr., is an activemember of the faculty at Stanford. Currently, he is a member of the Board of Directors and he holds the position of Professor of Neurosurgery andRadiation Oncology at Stanford. At June 30, 2008 and 2007, amounts of $231,000 and $231,000, respectively, were recorded as deferred revenue andadvances relating to related party payments made by Stanford. At June 30, 2008 and 2007, no related party113Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)11. Related Party Transactions (Continued)amounts were due from Stanford. The Company also has a license agreement with Stanford as disclosed in Note 7. In April 2006, the Company entered into a consulting agreement with Dr. Adler, which terminated any prior consulting agreements. Under thisconsulting agreement, Dr. Adler was entitled to receive a maximum compensation of $137,000 per year, payable at the beginning of each quarterbeginning on April 1, 2006. In April 2007, the Company entered into a new consulting agreement with Dr. Adler, which terminated the prior consultingagreement. Under this consulting agreement, Dr. Adler was entitled to receive a maximum compensation of $149,100 per year, payable at the beginningof each quarter beginning on April 1, 2007. In April 2008, the Company entered into a new consulting agreement with Dr. Adler, which terminated the prior consulting agreements discussedabove. Under the new consulting agreement, Dr. Adler is entitled to receive a maximum compensation of $167,100 per year, payable in quarterlyinstallments at the beginning of each quarter beginning on April 1, 2008. This agreement has a term of one year and will renew for successive one-yearperiods, unless either party provides 30 days' written notice of termination prior to the expiration of each one-year period. The Company recognizedconsulting expense for Dr. Adler in the amounts of $154,000, $178,000 and $155,000 for the years ended June 30, 2008, 2007 and 2006, respectively,pursuant to these agreements. The Company recognized related party revenue of $1.2 million, $5.3 million and $5.6 million during the years ended June 30, 2008, 2007 and2006, respectively, relating to products and services provided to Meditec. Meditec's parent, Marubeni Corporation, was a common stockholder of theCompany. Marubeni Corporation transferred its interest in the Company during September 2007 and is no longer a stockholder of record of theCompany as of June 30, 2008. At June 30, 2008 and 2007, $0 and $20.1 million, respectively, were recorded as deferred revenue and advances relatingto related party payments made by Meditec for certain products and services. At June 30, 2008 and 2007, no amounts were due from Meditec. The Company recognized related party revenue of $0, $0 and $130,000 during the years ended June 30, 2008, 2007 and 2006, relating to productsand services provided to President Medical Technology Co. ("President"). President is related to President International Investment Holdings, Ltd.,which is a common stockholder of the Company. In May 2006, President International Investment Holdings, Ltd. sold all of its interest in President. AtJune 30, 2008 and 2007, no amounts were recorded as deferred revenue and advances relating to related party payments made by President, nor wererelated party amounts due.12. Employee Benefit Plans The Company's employee savings and retirement plan is qualified under Section 401(k) of the United States Internal Revenue Code. Employeesmay make voluntary, tax-deferred contributions to the 401(k) Plan up to the statutorily prescribed annual limit. The Company makes discretionarymatching contributions to the 401(k) Plan on behalf of employees up to the limit determined by the Board of Directors. The Company contributed$845,000, $730,000 and $528,000 to the 401(k) Plan during the years ended June 30, 2008, 2007 and 2006, respectively.114Accuray IncorporatedNotes to Consolidated Financial Statements (Continued)13. Quarterly Financial Data (unaudited) Quarters ended September 30,2007 December 31,2007 March 31,2008 June 30,2008 (in thousands, except per share data) Net revenue $48,646 $52,038 $58,758 $50,939 Gross profit $25,911 $27,862 $26,283 $26,896 Net income $2,265 $2,343 $584 $191 Basic net income per share $0.04 $0.04 $0.01 $0.00 Diluted net income per share $0.04 $0.04 $0.01 $0.00 Shares used in basic per share calculation 54,025 54,737 54,856 54,506 Shares used in diluted per share calculation 61,154 61,293 60,125 58,854 Quarters ended September 30,2006 December 31,2006 March 31,2007 June 30,2007 (in thousands, except per share data) Net revenue $32,771 $26,347 $37,340 $43,994 Gross profit $19,303 $14,702 $21,118 $24,916 Net income (loss) before cumulative effect of change in accounting principle $1,120 $(7,291)$(785)$502 Net income (loss)(1) $1,958 $(7,291)$(785)$502 Basic net income (loss) per share $0.05 $(0.45)$(0.02)$0.01 Diluted net income (loss) per share $0.04 $(0.45)$(0.02)$0.01 Shares used in basic per share calculation 41,445 16,209 37,018 53,732 Shares used in diluted per share calculation 49,851 16,209 37,018 62,553 (1)Includes $838,000 in the quarter ended September 30, 2006 for the cumulative effect of a change in accounting principle for the adoption ofFAS 123R.14. Subsequent Event On July 29, 2008, the Company and Morphormics, Inc. ("Morphormics") entered into a Stock Purchase Agreement pursuant to which theCompany agreed to purchase 120,000 shares of Morphormics Series C Preferred Stock at $12.50 per share, for a total purchase price of $1.5 million. Inexchange, Morphormics granted the Company a non-exclusive worldwide license to integrate several of its software products into the Company'streatment planning software. Such investment will not include any governance rights in Morphormics. The equity investment afforded the Company aninterest of approximately 8% in the Morphormics upon execution.115Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable.Item 9A. EVALUATION OF DISCLOSURE CONTROL AND PROCEDURES AND MANAGEMENT'S REPORT ON INTERNALCONTROL OVER FINANCIAL REPORTING a) Evaluation of Disclosure Controls and Procedures Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosurecontrols and procedures as of June 30, 2008. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of theend of the period covered by our Annual Report on Form 10-K, due to the material weakness in internal control over financial reporting as discussedbelow under "Report of Management on Internal Control Over Financial Reporting," our disclosure controls and procedures were not effective inproviding reasonable assurance that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure and that such information is recorded, processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms.b) Report of Management on Internal Control over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, managementconducted an evaluation of the effectiveness of internal controls over financial reporting based upon the framework in "Internal Control—IntegratedFramework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. As previously reported in our Annual Report on Form 10-K for the year ended June 30, 2007, material weaknesses and significant deficiencies inour internal controls over financial reporting were identified in prior years. Those material weaknesses and significant deficiencies related to a lack ofsegregation of duties, inadequate review procedures and the misapplication of accounting policies, related to revenue recognition and stock-basedcompensation. Throughout the year ended June 30, 2008, we implemented procedures designed to correct these material weaknesses and significantdeficiencies noted above, including implementation of new processes and controls, the expansion of our accounting staff to efficiently and timelyexecute our new procedures and enhancement of the training and education for our finance and accounting personnel. During the year ended June 30, 2008, management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated theeffectiveness of internal controls over financial reporting. Although we noted that our remediation efforts had been partly successful, including thoserelated to segregation of duties and stock-based compensation, we continued to identify control deficiencies. The deficiencies consisted of a combinationof inadequate communication and review procedures, and misapplication of accounting policies relating to our accounting for revenue transactions thatresulted in accounting adjustments during the period. Management has determined that these control deficiencies aggregate to form a material weakness. We recognize revenue from a range of transactions including CyberKnife system sales, our shared ownership program and services. TheCyberKnife system is a complex product that contains both hardware and software elements. The complexity of the CyberKnife system and of ourfinancial model116requires us to process a broader range of financial transactions, particularly related to revenue recognition, than would be required by a company with aless complex financial model. We will continue to implement procedures designed to correct this material weakness, including implementing additionalprocesses and controls, further expanding our accounting staff to efficiently and timely execute our procedures and further enhancing the training andeducation for both finance and non-finance personnel involved with our revenue transactions. Based on this evaluation, management concluded that our internal control over financial reporting was not effective as of June 30, 2008, basedupon the framework in "Internal Control—Integrated Framework". Grant Thornton LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this AnnualReport on Form 10-K and, as part of the audit, has issued a report, included herein, on the effectiveness of our internal controls over financial reportingas of June 30, 2008.Changes in Internal Control over Financial Reporting. As noted above, for the fiscal year ended June 30, 2008, we reported one material weakness. Our efforts to remediate this material weakness in ourinternal controls over financial reporting, related to revenue recognition, consist of the following corrective actions: (i) hiring additional qualified financeand accounting personnel; (ii) strengthening our processes and procedures related to complex revenue recognition transactions; and (iii) providingadditional training for both finance and non-finance personnel involved with our revenue transactions. However, even after these corrective actions areimplemented, the effectiveness of our controls and procedures may be limited by a variety of risks. There were no changes in our internal control over financial reporting, other than those stated above, during our most recent fiscal quarter that havematerially affected, or are reasonably likely to materially affect, our internal control over financial reporting.Inherent Limitations of Internal Controls Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherentlimitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment andbreakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper managementoverride. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal controlover financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to designinto the process safeguards to reduce, though not eliminate, this risk.117REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and StockholdersAccuray Incorporated We have audited Accuray Incorporated and subsidiaries' (the "Company") internal control over financial reporting as of June 30, 2008, based oncriteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over FinancialReporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that amaterial weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performingsuch other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company'sinternal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have amaterial effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate. A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is areasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timelybasis. The following material weakness has been identified and included in management's assessment. Exceptions were identified in the operation of the Company's internal controls over accounting for revenue transactions. Those exceptions relatedto inadequate communication and review procedures and the misapplication of accounting policies that aggregated to form a material weakness. In our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, AccurayIncorporated and subsidiaries has not maintained effective internal control over financial reporting as of June 30, 2008, based on criteria established inInternal Control—Integrated Framework issued by COSO.118 We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanyingconsolidated balance sheets of Accuray Incorporated and subsidiaries as of June 30, 2008 and 2007 and the related consolidated statements ofoperations, stockholders' equity (deficiency), and cash flows for each of the three years in the period ended June 30, 2008. The material weaknessidentified above was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2008 financial statements, and thisreport does not affect our report dated September 5, 2008, which expressed an unqualified opinion on those financial statements. We do not express an opinion or any other form of assurance on the corrective actions and other changes in internal controls reported in the Reportof Management on Internal Control over Financial Reporting. /s/ GRANT THORNTON LLPSan Francisco, CaliforniaSeptember 5, 2008 Item 9B. OTHER INFORMATION Not applicable.119PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE. Directors, Executive Officers and Corporate Governance The information in our 2008 Proxy Statement regarding Directors and Executive officers appearing under the headings "Proposal One—Electionof Directors", "Corporate Governance and Board of Directors Matters", "Executive Officers" and "Section 16(a) Beneficial Ownership ReportingCompliance" is incorporated herein by reference. In addition, the information in our 2008 Proxy Statement regarding the director nomination process, the Audit Committee financial expert and theidentification of the Audit Committee members appearing under the heading "Corporate Governance and Board of Directors Matters" is incorporatedherein by reference. There have been no material changes to the procedures by which stockholders may recommend nominees to our Board.Code of Conduct and Ethics We have adopted a Code of Conduct and Ethics that applies to all employees including principal executive officer and principal financial officer.The full texts of our codes of business conduct and ethics are posted on our website at http://www.accuray.com under the Investor Relations section.The inclusion of our Web site address in this report does not include or incorporate by reference the information on our Web site into this report.ITEM 11. EXECUTIVE COMPENSATION The information in our 2008 Proxy Statement appearing under the headings "Executive Compensation", "Report of the Compensation Committee","Compensation Discussion and Analysis", and "Compensation Committee Interlocks and Insider Information" is incorporated herein by reference.Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS The information in our 2008 Proxy Statement appearing under the heading "Security Ownership of Certain Beneficial Owners and Management"is incorporated herein by reference.120Equity Compensation Plan Information The following table sets forth as of June 30, 2008 certain information regarding our equity compensation plans. All of our equity compensationplans have been approved by our security holders. A B C Plan category Number of securitiesto be issued uponexercise ofoutstanding options,warrants, and rights Weighted-average exerciseprice of outstandingoptions, warrants, andrights Number of securitiesremaining availablefor future issuanceunder equitycompensation plans(excluding securitiesreflected in ColumnA)(1) Equity compensation plans approved by security holders 9,212,831 $5.70 2,226,181 Equity compensation plans not approved by security holders — — — Total 9,212,831 $5.70 2,226,181 (1)Includes securities to be issued upon vesting of 724,034 restricted stock units at a grant date fair value of $23.43.Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information in our 2008 Proxy Statement appearing under the headings "Certain Relationships and Related Party Transactions" and"Corporate Governance—Director Independence" is incorporated herein by reference.Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information in our 2008 Proxy Statement appearing under the headings "Proposal Two—Ratification of Appointment of IndependentRegistered Public Accounting Firm—Audit and Non-Audit Services" and "Proposal Two—Ratification of Appointment of Independent RegisteredPublic Accounting Firm—Audit Committee Pre-Approval Policies and Procedures" is incorporated herein by reference.Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Financial Statements The financial statements of Accuray Incorporated are set forth in Item 8 of this Report.(b) Financial Statement Schedules SCHEDULE IIValuation and Qualifying Accounts BeginningBalance Charges(Deductions)toOperations Write-offs EndingBalance Accounts receivable allowances Year ended June 30, 2006 $45 (21) (4)$20 Year ended June 30, 2007 $20 2 (2)$20 Year ended June 30, 2008 $20 30 (23)$27 121(c) Exhibits The following exhibits are incorporated by reference or filed herewith. 2.1 Agreement and Plan of Merger of Accuray Incorporated, a Delaware Corporation, and Accuray Incorporated, a California Corporation, datedas of February 3, 2007.(1) 3.2 Amended and Restated Certificate of Incorporation of Registrant.(1) 3.4 Amended and Restated Bylaws of Registrant.(1) 4.2 Investors' Rights Agreement dated October 30, 2006 by and between Registrant and purchasers of Series A Preferred Stock, Series A1Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and certain holders of common stock.(1) 4.3 Form of Common Stock Certificate.(1) 10.1 Industrial Complex Lease dated July 14, 2003 by and between Registrant and MP Caribbean, Inc., as amended by the First Amendment toIndustrial Complex Lease effective as of December 9, 2004 and the Second Amendment to Industrial Complex Lease effective as ofSeptember 25, 2006.(1) 10.1(a)Third Amendment to Industrial Complex Lease dated January 16, 2007.(2) 10.2 Standard Industrial Lease effective as of June 30, 2005 by and between Registrant and The Realty Associates Fund III, L.P.(1) 10.3*Accuray Incorporated 1993 Stock Option Plan and forms of agreements relating thereto.(1) 10.4*Accuray Incorporated 1998 Equity Incentive Plan and forms of agreements relating thereto.(1) 10.5*Accuray Incorporated 2007 Incentive Award Plan and forms of agreements relating thereto.(1) 10.6*Accuray Incorporated 2007 Employee Stock Purchase Plan and forms of agreements relating thereto.(1) 10.7*Form of Indemnification Agreement by and between Registrant and each of its directors and executive officers.(1) 10.8*Employment Terms Letter dated November 10, 2006 by and between Registrant and Euan S. Thomson, Ph.D.(1) 10.9*Employment Terms Letter dated November 10, 2006 by and between Registrant and Chris A. Raanes.(1) 10.10*Employment Terms Letter dated November 10, 2006 by and between Registrant and Robert E. McNamara.(1) 10.11 Offer Letter dated July 22, 2004 by and between Registrant and John W. Allison, Ph.D.(1) 10.12*Employment Terms Letter dated November 10, 2006 by and between Registrant and Eric Lindquist.(1) 10.13*Employment Terms Letter dated November 10, 2006 by and between Registrant and Wade Hampton.(1) 10.16 License Agreement effective as of December 12, 2004 by and between Registrant and American Science and Engineering, Inc.(1)122 10.17 Assignment & Assumption of License and Consent by Supplier effective as of January 10, 2005 by and among Registrant, American Scienceand Engineering, Inc., Yuri Batygin, and Anatoliy Zapreier.(1) 10.18 Nonexclusive End-User Software License Agreement dated September 9, 2005 by and between Registrant and The Regents of the Universityof California.(1) 10.19 License Agreement effective as of July 9, 1997 by and between Registrant and The Board of Trustees of the Leland Stanford JuniorUniversity.(1) 10.20 Manufacturing License and Technology Transfer Agreement effective as of January 28, 1991 by and between Registrant and SchonbergRadiation Corporation, as amended on April 15, 1996 and November 11, 2002.(1) 10.21 Non-Exclusive System Partner Agreement effective as of September 23, 2005 by and between Registrant and KUKA RoboticsCorporation.(1) 10.22 Consulting Agreement effective as of March 11, 2004 by and between Registrant and Forte Automation Systems, Inc.(1) 10.23 Amended and Restated International Distributor Agreement effective as of April 1, 2004 by and between Registrant and President MedicalTechnologies Co., Ltd. Inc.(1) 10.24 Commission Agreement effective as of August 10, 2006 by and between Registrant and President Medical Technologies Co., Ltd. Inc.(1) 10.25 Assignment Agreement effective as of December 29, 2004 by and between President Medical Technologies Co., Ltd. Inc. and CowealthMedical Science & Biotechnology Incorporated.(1) 10.26 International Distributor Agreement dated January 21, 2004 by and between Registrant and Chiyoda Technol Corporation.(1) 10.27 Separation Agreement and Release effective as of April 14, 2006 by and between Registrant and John W. Allison, Ph.D.(1) 10.28 Asset Purchase Agreement effective as of December 12, 2004 by and between the Registrant and American Science and Engineering, Inc.(1) 10.29 Exclusive Manufacturing Agreement effective as of November 29, 2006 by and between the Registrant and Forte AutomationSystems, Inc.(1) 10.30 Letter Agreement dated May 20, 2003 by and between the Registrant and Meditec Corporation.(1) 10.31†CyberKnife Transfer Agreement effective as of March 6, 2006 by and between the Registrant, Marubeni Corporation and MeditecCorporation.(1) 10.32†Patent and Trademark License Agreement effective as of November 29, 2006 by and between the Registrant and Forte AutomationSystems, Inc.(1) 10.33††Distribution and Remarketing Agreement dated April 3, 2007 by and between the Registrant and Siemens Medical Solutions, Oncology CareSystems Group.(2) 10.34††License and Development Agreement dated April 27, 2007 by and between the Registrant and CyberHeart, Inc.(2) 10.35 Independent Contractor Agreement effective as of April 1, 2008 by and between Registrant and John R. Adler, M.D.123 10.36*Employment Terms Letter dated May 3, 2007 by and between Registrant and Christopher Mitchell.(2) 10.37*Employment Terms Letter effective as of July 2, 2007 by and between Registrant and Theresa Dadone.(2) 21.1 List of subsidiaries. 23.1 Consent of Grant Thornton LLP, independent registered public accounting firm. 24.1 Power of Attorney (see page 125) 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 and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)Incorporated by reference to the same numbered exhibit to Amendment No. 6 to Registrant's Registration Statement on Form S-1 filed with theSecurities and Exchange Commission on February 7, 2007 (No. 333-138622). (2)Incorporated by reference to Registrant's Form 10-K for the fiscal year ended June 30, 2007 filed with the Securities and Exchange Commissionon August 31, 2007. *Management contract or compensatory plan or arrangement. †Portions of the exhibit have been omitted pursuant to a request for confidential treatment, which has been granted. The omitted information hasbeen filed separately with the Securities and Exchange Commission. ††Portions of the exhibit have been omitted pursuant to a request for confidential treatment. The omitted information has been filed separately withthe Securities and Exchange Commission. The certifications attached as Exhibit 32.1 and Exhibit 32.2 that accompany this Annual Report on Form 10-K are not deemed filed with theSecurities and Exchange Commission and are not to be incorporated by reference into any filing of Accuray Incorporated under the Securities Act of1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Annual Report on Form 10-K, irrespective of any generalincorporation language contained in such filing.124SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized, in the City of Sunnyvale, State of California, on the 9th day of September 2008. ACCURAY INCORPORATED By: /s/ EUAN S. THOMSON, PH.D.Euan S. Thomson, Ph.D.President and Chief Executive Officer By: /s/ ROBERT E. MCNAMARARobert E. McNamaraSenior Vice President and Chief Financial OfficerPOWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints Euan S.Thomson, Ph.D. and Robert E. McNamara, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution, forhim and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file thesame, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto saidattorneys-in-fact and agents, full power and authority to do and perform each and every act and thing requisite and necessary to be done therewith, asfully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, and any ofthem or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following and on the datesindicated.Signature Title Date /s/ EUAN S. THOMSON, PH.DEuan S. Thomson, Ph.D President and Chief Executive Officerand Director (principal executiveofficer) September 9, 2008/s/ ROBERT E. MCNAMARARobert E. McNamara Senior Vice President, ChiefFinancial Officer (principal financialand accounting officer) September 9, 2008/s/ WAYNE WUWayne Wu Chairman of the Board and Director September 9, 2008125Signature Title Date /s/ JOHN R. ADLER, JR., M.D.John R. Adler, Jr., M.D. Director September 9, 2008/s/ TED T. C. TUTed T. C. Tu Director September 5, 2008/s/ ROBERT S. WEISSRobert S. Weiss Director September 5, 2008/s/ LI YULi Yu Director September 8, 2008/s/ JOHN WAREHAMJohn Wareham Director September 8, 2008/s/ ELIZABETH DÁVILAElizabeth Dávila Director September 8, 2008126Exhibit Index ExhibitNo. 2.1 Agreement and Plan of Merger of Accuray Incorporated, a Delaware Corporation, and Accuray Incorporated, a California Corporation, datedas of February 3, 2007.(1) 3.2 Amended and Restated Certificate of Incorporation of Registrant.(1) 3.4 Amended and Restated Bylaws of Registrant.(1) 4.2 Investors' Rights Agreement dated October 30, 2006 by and between Registrant and purchasers of Series A Preferred Stock, Series A1Preferred Stock, Series B Preferred Stock and Series C Preferred Stock and certain holders of common stock.(1) 4.3 Form of Common Stock Certificate.(1) 10.1 Industrial Complex Lease dated July 14, 2003 by and between Registrant and MP Caribbean, Inc., as amended by the First Amendment toIndustrial Complex Lease effective as of December 9, 2004 and the Second Amendment to Industrial Complex Lease effective as ofSeptember 25, 2006.(1) 10.1(a)Third Amendment to Industrial Complex Lease dated January 16, 2007.(2) 10.2 Standard Industrial Lease effective as of June 30, 2005 by and between Registrant and The Realty Associates Fund III, L.P.(1) 10.3*Accuray Incorporated 1993 Stock Option Plan and forms of agreements relating thereto.(1) 10.4*Accuray Incorporated 1998 Equity Incentive Plan and forms of agreements relating thereto.(1) 10.5*Accuray Incorporated 2007 Incentive Award Plan and forms of agreements relating thereto.(1) 10.6*Accuray Incorporated 2007 Employee Stock Purchase Plan and forms of agreements relating thereto.(1) 10.7*Form of Indemnification Agreement by and between Registrant and each of its directors and executive officers.(1) 10.8*Employment Terms Letter dated November 10, 2006 by and between Registrant and Euan S. Thomson, Ph.D.(1) 10.9*Employment Terms Letter dated November 10, 2006 by and between Registrant and Chris A. Raanes.(1) 10.10*Employment Terms Letter dated November 10, 2006 by and between Registrant and Robert E. McNamara.(1) 10.11 Offer Letter dated July 22, 2004 by and between Registrant and John W. Allison, Ph.D.(1) 10.12*Employment Terms Letter dated November 10, 2006 by and between Registrant and Eric Lindquist.(1) 10.13*Employment Terms Letter dated November 10, 2006 by and between Registrant and Wade Hampton.(1) 10.16 License Agreement effective as of December 12, 2004 by and between Registrant and American Science and Engineering, Inc.(1)127ExhibitNo. 10.17 Assignment & Assumption of License and Consent by Supplier effective as of January 10, 2005 by and among Registrant, American Scienceand Engineering, Inc., Yuri Batygin, and Anatoliy Zapreier.(1) 10.18 Nonexclusive End-User Software License Agreement dated September 9, 2005 by and between Registrant and The Regents of the Universityof California.(1) 10.19 License Agreement effective as of July 9, 1997 by and between Registrant and The Board of Trustees of the Leland Stanford JuniorUniversity.(1) 10.20 Manufacturing License and Technology Transfer Agreement effective as of January 28, 1991 by and between Registrant and SchonbergRadiation Corporation, as amended on April 15, 1996 and November 11, 2002.(1) 10.21 Non-Exclusive System Partner Agreement effective as of September 23, 2005 by and between Registrant and KUKA RoboticsCorporation.(1) 10.22 Consulting Agreement effective as of March 11, 2004 by and between Registrant and Forte Automation Systems, Inc.(1) 10.23 Amended and Restated International Distributor Agreement effective as of April 1, 2004 by and between Registrant and President MedicalTechnologies Co., Ltd. Inc.(1) 10.24 Commission Agreement effective as of August 10, 2006 by and between Registrant and President Medical Technologies Co., Ltd. Inc.(1) 10.25 Assignment Agreement effective as of December 29, 2004 by and between President Medical Technologies Co., Ltd. Inc. and CowealthMedical Science & Biotechnology Incorporated.(1) 10.26 International Distributor Agreement dated January 21, 2004 by and between Registrant and Chiyoda Technol Corporation.(1) 10.27 Separation Agreement and Release effective as of April 14, 2006 by and between Registrant and John W. Allison, Ph.D.(1) 10.28 Asset Purchase Agreement effective as of December 12, 2004 by and between the Registrant and American Science and Engineering, Inc.(1) 10.29 Exclusive Manufacturing Agreement effective as of November 29, 2006 by and between the Registrant and Forte Automation Systems, Inc.(1) 10.30 Letter Agreement dated May 20, 2003 by and between the Registrant and Meditec Corporation.(1) 10.31†CyberKnife Transfer Agreement effective as of March 6, 2006 by and between the Registrant, Marubeni Corporation and MeditecCorporation.(1) 10.32†Patent and Trademark License Agreement effective as of November 29, 2006 by and between the Registrant and Forte AutomationSystems, Inc.(1) 10.33††Distribution and Remarketing Agreement dated April 3, 2007 by and between the Registrant and Siemens Medical Solutions, Oncology CareSystems Group.(2) 10.34††License and Development Agreement dated April 27, 2007 by and between the Registrant and CyberHeart, Inc.(2)128ExhibitNo. 10.35 Independent Contractor Agreement effective as of April 1, 2008 by and between Registrant and John R. Adler, M.D. 10.36*Employment Terms Letter dated May 3, 2007 by and between Registrant and Christopher Mitchell.(2) 10.37*Employment Terms Letter effective as of July 2, 2007 by and between Registrant and Theresa Dadone.(2) 21.1 List of subsidiaries. 23.1 Consent of Grant Thornton LLP, independent registered public accounting firm. 24.1 Power of Attorney (see page 125) 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 and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.(1)Incorporated by reference to the same numbered exhibit to Amendment No. 6 to Registrant's Registration Statement on Form S-1 filed with theSecurities and Exchange Commission on February 7, 2007 (No. 333-138622). (2)Incorporated by reference to Registrant's Form 10-K for the fiscal year ended June 30, 2007 filed with the Securities and Exchange Commissionon August 31, 2007. *Management contract or compensatory plan or arrangement. †Portions of the exhibit have been omitted pursuant to a request for confidential treatment, which has been granted. The omitted information hasbeen filed separately with the Securities and Exchange Commission. ††Portions of the exhibit have been omitted pursuant to a request for confidential treatment. The omitted information has been filed separately withthe Securities and Exchange Commission. The certifications attached as Exhibit 32.1 and Exhibit 32.2 that accompany this Annual Report on Form 10-K are not deemed filed with theSecurities and Exchange Commission and are not to be incorporated by reference into any filing of Accuray Incorporated under the Securities Act of1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Annual Report on Form 10-K, irrespective of any generalincorporation language contained in such filing.129QuickLinksDOCUMENTS INCORPORATED BY REFERENCEACCURAY INCORPORATED YEAR ENDED JUNE 28, 2008 FORM 10-K ANNUAL REPORT TABLE OF CONTENTSSPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTSPART IItem 1A. Risk FactorsItem 1B. UNRESOLVED STAFF COMMENTSItem 2. PROPERTIESItem 3. LEGAL PROCEEDINGSItem 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSPART IIItem 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF EQUITY SECURITIESItem 6. SELECTED FINANCIAL DATAItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSItem 7A. QUANTITATIVE & QUALITATIVE DISCLOSURE ABOUT MARKET RISKItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAACCURAY INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTSREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMAccuray Incorporated Consolidated Balance Sheets (in thousands, except share and per share amounts)Accuray Incorporated Consolidated Statements of Operations (in thousands, except per share amounts)Accuray Incorporated Consolidated Statement of Stockholders' Equity (Deficiency) (in thousands, except share amounts)Accuray Incorporated Consolidated Statements of Cash Flows (in thousands)Accuray Incorporated Notes to Consolidated Financial StatementsItem 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSUREItem 9A. EVALUATION OF DISCLOSURE CONTROL AND PROCEDURES AND MANAGEMENT'S REPORT ON INTERNALCONTROL OVER FINANCIAL REPORTINGREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMItem 9B. OTHER INFORMATIONPART IIIITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.ITEM 11. EXECUTIVE COMPENSATIONItem 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERSItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCEItem 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESItem 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULESSIGNATURESPOWER OF ATTORNEYExhibit Index Exhibit 10.35 Initials: Contractor /s/ J.A.Accuray /s/ C.D.M. ACCURAY INDEPENDENT CONTRACTOR AGREEMENT This Independent Contractor Agreement (“Agreement”) is made effective as of April 1, 2008 by and between Accuray Incorporated, aDelaware corporation (the “Company”), and John Adler, M.D. (“Contractor” and, together with the Company, the “Parties”). The Company desires to retainContractor as an independent contractor to perform certain services for the Company and Contractor is willing to perform such services, on terms set forthmore fully below. In consideration of the mutual promises contained herein, the Parties agree as follows: 1. Services. During the term of this agreement, Contractor will provide services (the “Services”) to the Company as described on Exhibit A attached tothis Agreement. Contractor shall use his best efforts to perform the Services to the satisfaction of the Company and by the completion dates specified by theCompany. Contractor shall not perform any Services for the Company other than as specifically authorized in Exhibit A. 2. Independent Contractor Status. It is the Parties’ intent that Contractor at all times, and with respect to all Services covered by this Agreement function as and remain an independentcontractor, and not an employee or officer of the Company, and neither Party shall represent to third parties that Contractor is an employee or officer of theCompany. (a) Contractor shall be responsible for the payment of all taxes on amounts received from the Company for the Services. TheCompany will regularly report amounts paid to Contractor by filing Form 1099-MISC with the Internal Revenue service, as required by law. No part ofContractor’s fees will be subject to withholding by the Company for payment of any social security, federal, state or other employee payroll taxes. Contractoragrees to indemnify and hold the Company harmless from any liability for, or assessment of, any such taxes imposed on the Company by relevant taxingauthorities. (b) Contractor shall retain the right to perform services for others during the term of this Agreement. (c) Contractor will determine the method, details, and means of performing the Services. The Company shall have no right to, andshall not control, the manner or determine the method of accomplishment of the Services, though it may define the Services to be performed. Such Servicesmay be amended, from time-to-time, by the Parties by written agreement, signed by the Contractor and the Company. INDEPENDENT CONTRACTOR AGREEMENTACCURAY CONFIDENTIALJohn Adler, M.D. — 2008, rev. 004, 03.13.08 1 ACCURAY (d) Contractor may, at Contractor’s own expense, employ such assistants as the Contractor may deem necessary to perform theServices. The Company shall not control, direct or supervise the work of Contractor’s assistants or employees in the performance of Services. The Contractorassumes full and sole responsibility for the quality of Services provided by the Contractor’s assistants or employees, for the payment of all compensation andexpenses of these assistants and employees, for state and federal income taxes and other applicable payroll taxes and withholding that may be required withrespect to such assistants or employees, and for the provision of all benefits and insurance, including without limitation, Worker’s Compensation Insurance,to such assistants or employees. Contractor shall furnish the Company with proof of Worker’s Compensation Insurance coverage for all persons who provideServices pursuant to this Agreement. (e) Contractor shall be responsible for all expenses incurred in the execution of Contractor’s responsibilities pursuant to thisAgreement, including, without limitation, all travel (including airfare and lodging), entertainment and dining expenses. No fines, taxes, bonds or fees imposedagainst Contractor, or costs of Contractor doing business, shall be reimbursable by the Company. (i) Contractor shall not be eligible to participate in any fringe benefit program or any benefit plan of the Company. (g) Contractor will have no authority to enter into contracts that bind the Company or to create obligations on the part of theCompany without the prior written authorization of the Company. (h) Contractor shall receive no office or administrative support from Company. (i) Contractor will, in the performance of his duties hereunder, comply with all policies and procedures of the Company that areapplicable to independent contractors and consultants, including but not limited to the Company’s Code of Conduct and Ethics and the Company’s Code ofConduct for Interaction with Healthcare Professionals. 3. Fees. As consideration for the Services to be provided by Contractor, the Company will compensate Contractor as described in Exhibit B to thisAgreement. Company will pay Contractor Contractor’s annual compensation in quarterly installments of $41,775, such quarterly installments to be paid inadvance of each quarter beginning on the date on which this Agreement is signed by both Parties and thereafter on the first business day of each quarter.Compensation for Contractor’s Services shall be conditioned on the actual performance by Contractor of Services and the Company’s receipt and approval ofaccurate and detailed quarterly invoices, including records of time spent and Services performed, from Contractor in the form attached hereto as Exhibit D. 2 ACCURAY Contractor shall submit such quarterly invoices for all Services performed by Contractor during the applicable quarter two (2) weeks prior to the end of suchquarter (for example, for the first quarterly period of this Agreement, April 1, 2008 to June 30, 2008, Contractor’s first quarterly invoice will be due toCompany no later than June 15, 2008). If for any quarter, Contractor has not provided the level of Services required to earn the full quarterly installment forsuch quarter, then the quarterly installment for Contractor for the following quarter will be reduced in an amount equal to the amount that Contractor wasovercompensated for the preceding quarter. If at the end of the term of this Agreement, Contractor has never performed certain services, and Contractor’s failureto perform such services has not been offset against any subsequent quarter’s installment, then Contractor will reimburse Company the corresponding amountfor the services not performed within thirty (30) calendar days. The Parties acknowledge that payment for the Services provided hereunder is consistent withthe fair market value of such Services and is not conditioned in any way on the volume or value of any business (i) between the Company and any otherparty, or (ii) resulting, directly or indirectly, from any of Contractor’s activities hereunder. 4. Confidentiality. (a) Confidential Information. “Confidential Information” means Company proprietary information, technical data, trade secretsor know-how, including, but not limited to, research, product plans, product specifications, services, customers, customer lists, pipeline documents,marketing plans and strategies, software, developments, inventions, processes, formulas, technology, designs, drawings, engineering, hardware configurationinformation, circuit board designs, logic designs for filters and/or circuit boards, Company financials or other business information disclosed by theCompany either directly or indirectly in writing, orally, or by drawings or inspection of parts or equipment. Confidential Information also includes any otherinformation designated by the Company as such upon its disclosure to the Contractor. (b) Disclosure. Contractor will not, during or subsequent to the term of this Agreement, use the Company’s ConfidentialInformation for any purpose whatsoever other than the performance of the Services on behalf of the Company. Contractor will not disclose the Company’sConfidential Information to any third party, and understands that said Confidential Information shall remain the sole property of the Company. Contractorfurther agrees to take all reasonable precautions to prevent any unauthorized disclosure of such Confidential Information including, but not limited to, havingeach employee of Contractor, if any, with access to any Confidential Information, execute a nondisclosure agreement containing provisions in the Company’sfavor substantially similar to Sections 4, 5 and 6 of this Agreement. Confidential Information does not include information which, upon disclosure toContractor is part of the public domain; can be established by written evidence to have been in the possession of Contractor at the time of disclosure; isreceived by Contractor from a third party without restriction and without breach of this Agreement; or has become publicly known and made generallyavailable through no wrongful act of Contractor. If Contractor is required to disclose Confidential Information by lawfully issued subpoena or by anauthorized order of a government agency, Contractor will immediately so inform 3 ACCURAY the Company, and will use best efforts to minimize the disclosure of such Confidential Information and will consult with and assist the Company in seeking aprotective order prior to such disclosure. (c) Indemnity. Contractor agrees that Contractor will not, during the term of this Agreement, improperly use or disclose to theCompany or any of its employees any proprietary information or trade secrets of any former or current employer or other person or entity with whichContractor has an agreement, or to which Contractor has a duty, to keep in confidence information acquired by Contractor, and that Contractor will not bringonto the premises of the Company any unpublished document, proprietary information, or trade secret belonging to such employer, person or entity unlessconsented to in writing by such employer, person or entity. Contractor will indemnify the Company and hold it harmless from and against all claims,liabilities, damages and expenses, including reasonable attorneys’ fees and costs of suit, arising out of or in connection with any violation or claimed violationof a third party’s rights resulting in whole or in part from the Services provided by Contractor under this Agreement. (d) Third Parties. Contractor recognizes that the Company has received and in the future will receive from third parties theirconfidential or proprietary information or trade secrets subject to a duty on the Company’s part to maintain the confidentiality of such information and to useit only for certain limited purposes. Contractor agrees that Contractor owes the Company and such third parties, during the term of this Agreement andthereafter, a duty to hold all such confidential or proprietary information or trade secrets in the strictest confidence and not to disclose it to any person, firm orcorporation or to use it except as necessary in carrying out the Services for the Company consistent with the Company’s agreement with such third party. (e) Return of Confidential Information. Upon the termination of this Agreement, or upon the Company’s earlier request,Contractor will deliver to the Company all of the Company’s property and all Confidential Information in tangible form that Contractor may have inContractor’s possession or control. 5. Ownership. (a) Inventions. Contractor agrees that all copyrightable material, notes, records, drawings, designs, inventions, improvements,developments, discoveries and trade secrets (collectively, “Inventions”) conceived, made or discovered by Contractor, solely or in collaboration with others,during the period of this Agreement which relate in any manner to the business of the Company that Contractor may be directed to undertake, investigate orexperiment with, or which Contractor may become associated with as a result of work, investigation or experimentation in the line of business of Company inperforming the Services hereunder (which Company and Contractor agree are related to Sales and Marketing), are the sole property of the Company.Contractor further agrees to assign (or cause to be assigned) and does hereby assign fully to the Company all such Inventions and any copyrights, patents,mask work rights or other intellectual property rights relating thereto. 4 ACCURAY (b) Assistance. Contractor agrees to assist Company, or its designee, at the Company’s expense, in every proper way to secure theCompany’s rights in the Inventions and any copyrights, patents, mask work rights or other intellectual property rights relating thereto in any and allcountries, including the disclosure to the Company of all pertinent information and data with respect thereto, the execution of all applications, specifications,oaths, assignments and all other instruments which the Company shall deem necessary in order to apply for and obtain such rights and in order to assign andconvey to the Company, its successors, assigns and nominees the sole and exclusive rights, title and interest in and to such Inventions, and any copyrights,patents, mask work rights or other intellectual property rights relating thereto. Contractor further agrees that Contractor’s obligation to execute or cause to beexecuted, when it is in Contractor’s power to do so, any such instrument or papers shall continue after the termination of this Agreement. (c) License. Contractor agrees that if in the course of performing the Services (which Company and Contractor acknowledge arerelated to Sales and Marketing), Contractor incorporates into any Invention developed hereunder any invention, improvement, development, concept,discovery or other proprietary information owned by Contractor or in which Contractor has an interest, the Company is hereby granted and shall have anonexclusive, royalty-free, perpetual, irrevocable, worldwide license to make, have made, modify, use and sell such item as part of or in connection with suchInvention. (d) Agent. Contractor agrees that if the Company is unable because of Contractor’s unavailability for any reason to secureContractor’s signature to apply for or to pursue any application for any United States or foreign patents or mask work or copyright registrations covering theInventions assigned to the Company above, then Contractor hereby irrevocably designates and appoints the Company and its duly authorized officers andagents as Contractor’s agent and attorney-in-fact, to act for and in Contractor’s behalf and stead to execute and file any such applications and to do all otherlawfully permitted acts to further the prosecution and issuance of patents, copyright and mask work registrations thereon with the same legal force and effectas if executed by Contractor. 6. Originality and Noninfringement. Contractor represents and warrants that all materials and Services provided hereunder will be original with Contractor and that the usethereof by the Company or its customers, representatives, distributors or dealers will not infringe any patent, copyright, trade secret or other intellectualproperty right of any third party. Contractor agrees to indemnify and hold the Company harmless against any liability, loss, cost, damage, claims, demandsor expenses (including reasonable attorneys’ fees) of the Company or its customers, representatives, distributors or dealers arising out of any infringement orclaim of infringement with respect to any materials or Services provided by Contractor. 5 ACCURAY 7. Reports. Contractor agrees that Contractor will, from time-to-time during the term of this Agreement, keep the Company informed as to Contractor’sprogress in performing the Services hereunder and that Contractor will, as requested by the Company, prepare written reports with respect thereto. The Partiesunderstand that the time required in the preparation of such written reports shall be considered time devoted to the performance of Contractor’s Services. 8. Conflicting Obligations. (a) Performance. Contractor acknowledges that Contractor will be available to perform the Services in a timely and responsiblemanner, except for the occasional circumstance in which a pre-existing clinical responsibility on the part of Contractor may conflict with a new commitmentrequested by the Company, subject to the requirements of the schedule of Services arranged by Company and Contractor pursuant to Section 1 of Exhibit Ahereto. Failure to perform in a timely and responsible manner shall be a breach of this Agreement. (b) No Conflicts. Contractor represents and warrants that Contractor has no outstanding agreement or obligation that is in conflictwith any provision of this Agreement, or that would preclude Contractor from complying with the provisions hereof, except as disclosed in Exhibit C hereto.Contractor further represents and warrants that Contractor will not enter into any such conflicting Agreement during the term of this Agreement. 9. Term and Termination. (a) Commencement. This Agreement will commence on the date first above written and will continue for a period of one year (the“Initial Term”). Unless 30 days’ written notice of termination is given by either Party prior to the expiration of the Initial Term, or any subsequent Term, thisAgreement shall renew for successive one-year periods. (b) Termination. This Agreement may be terminated as follows: (i) Either Party may terminate this Agreement with 90 days’ prior written notice to the other. Any such notice shall beaddressed to such Party at the address shown below or such other address as such Party shall provide to the other, and shall be deemed given upon delivery ifpersonally delivered, on the next business day if sent via overnight courier, or three days after deposit in the United States mail, postage prepaid, registered orcertified mail, return receipt requested. (ii) The Parties shall attempt to amend this Agreement upon receipt of any Governmental Action in order to comply with suchGovernmental Action. If the Parties, acting in good faith, are unable to make the amendments necessary to comply with such Governmental 6 ACCURAY Action, or, alternatively, if either Party determines in good faith that compliance with the Governmental Action is impossible or infeasible, this Agreementshall terminate 10 days after one Party notifies the other of such fact. For purposes of this Section 9(b)(ii), the term “Governmental Action” shall mean anylegislation, regulation, rule or procedure passed, adopted or implemented by any federal, state or local government or legislative body or any private agency, orany notice of a decision, finding, interpretation or action by any governmental or private agency, court or other third party which, in the opinion of counsel tothe Company, because of the arrangement between the Parties pursuant to this Agreement, if or when implemented, would: (A) constitute a violation of anyfederal, state or local law; or (B) subject either Party, or any of their respective employees or agents, to civil or criminal liability or prosecution on the basis oftheir participation in executing this Agreement or performing their respective obligations under this Agreement. (iii) If this Agreement is terminated for any reason within one-year of the date first above written, the Parties shall not enter into thesame or substantially the same arrangement contemplated by this Agreement during the period which is one (1) year following the date first above written. (c) Survival. Upon such termination, all rights and duties of the Parties toward each other shall cease except: (i) that the Company shall be obliged to pay, within 30 days of receipt of the Contractor’s invoice, all amounts owing toContractor for unpaid Services through the termination date; and (ii) Sections 4, 5, 6, 9 and 11 shall survive termination of this Agreement. 10. Assignment. Neither this Agreement nor any right hereunder or interest herein may be assigned or transferred by the Company or the Contractor withoutthe written consent of the other. 11. Arbitration and Equitable Relief. (a) Arbitration. Except as provided in Section 11(b) below, the Company and Contractor agree that any dispute or controversyarising out of or relating to any interpretation, construction, performance or breach of this Agreement shall be settled by arbitration to be held in Santa ClaraCounty, California before a single, neutral arbitrator associated with the Judicial Arbitration and Mediation Service (“JAMS”). The arbitrator shall be selectedby the Parties or, if the Parties are unable to agree, by JAMS, in accordance with its selection practices. The arbitrator may grant injunctions or other relief insuch dispute or controversy. The decision of the arbitrator shall be final, conclusive, and binding on the Parties to the arbitration. Judgment may be entered onthe arbitrator’s decision in any court of competent jurisdiction. Unless otherwise required to 7 ACCURAY preserve the enforceability of this arbitration clause, the Company and Contractor shall each pay one-half of the costs and expenses of such arbitration. (b) Equitable Relief. Contractor agrees that it would be impossible or inadequate to measure and calculate the Company’s damagesfrom any breach of the covenants set forth in Section 4 or 5 herein. Accordingly, Contractor agrees that if Contractor breaches Sections 4 or 5, the Companywill have available, in addition to any other right or remedy available, the right to obtain from any court of competent jurisdiction an injunction restrainingsuch breach or threatened breach and specific performance of any such provision. Contractor further agrees that no bond or other security shall be required inobtaining such equitable relief and Contractor hereby consents to the issuances of such injunction and to the ordering of such specific performance. 12. Miscellaneous. (a) Amendments and Waivers. Any term of this Agreement may be amended or waived only with the written consent of the Parties. (b) Entire Agreement. This Agreement, including the Exhibits hereto, constitutes the entire agreement of the Parties and supersedesand replaces all oral negotiations and prior writings with respect to the subject matter hereof. (c) Notices. Any notice required or permitted by this Agreement shall be in writing and shall be deemed sufficient upon receipt, whendelivered personally or by courier or overnight delivery service, or three days after being deposited in the regular United States mail as certified or registeredmail (airmail if sent internationally) with postage prepaid, if such notice is addressed to the party to be notified at such party’s address or facsimile number asset forth below, or as subsequently modified by written notice. (d) Governing Law. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws ofthe State of California, without giving effect to its principles of conflict of laws. (e) Legal Fees. If any dispute arises between the Parties with respect to matters covered by this Agreement which leads to aproceeding, pursuant to Section 11, to resolve such dispute, the prevailing party in any such proceeding shall be entitled to receive its reasonable attorneys’fees, expert witness fees and out-of-pocket costs incurred in connection with such proceeding, in addition to any other relief to which it may be entitled. (f) Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, then suchunenforceable provision shall be deemed modified so as to be enforceable (or if not subject to modification then eliminated herefrom) for the purpose of thoseprocedures to the extent necessary to permit the remaining provisions to be enforced. 8 ACCURAY (g) Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of whichtogether will constitute one and the same instrument. (h) Advice of Counsel. EACH PARTY ACKNOWLEDGES THAT, IN EXECUTING THIS AGREEMENT, SUCH PARTYHAS HAD THE OPPORTUNITY TO SEEK THE ADVICE OF INDEPENDENT LEGAL COUNSEL, AND HAS READ AND UNDERSTOOD ALLOF THE TERMS AND PROVISIONS OF THIS AGREEMENT. THIS AGREEMENT SHALL NOT BE CONSTRUED AGAINST ANY PARTY BYREASON OF THE DRAFTING OR PREPARATION HEREOF. (i) Compliance with Laws. The Parties agree to abide by the Company’s compliance policies and all federal, state or local laws,regulations, ordinances or other legal requirements in connection with the performance of the Services hereunder. In addition, at all times during thisAgreement, Contractor shall have in effect all ILLEGIBLE permits and authorizations for all local, state, federal and foreign governmental agencies to theextent the same are necessary to the performance of the Services hereunder and will verify all such licenses, permits and authorizations are in place beforeperforming any Services under this Agreement. Consultant shall not perform any Services under this Agreement for which he does not hold all necessarylicenses, permits and authorizations and will hold the Company harmless in all respects for any claims or actions resulting from Contractor’s violation of thisprovision. [SIGNATURE PAGE FOLLOWS] 9 ACCURAY IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as of the day and year first written above. JOHN ADLER, M.D.ACCURAY, INC. Signature:/s/ John Adler, M.D.Signature:/s/ Wade Hampton Name:John Adler, M.D.Name:Wade Hampton Title:ContractorTitle:SVP, Chief Sales Officer Address:854 Tolman DriveAddress:1310 Chesapeake TerraceStanford, CA 94305Sunnyvale, CA 94089 Telephone:(650) 854-9626Telephone:817-296-7096 Date:3/29/08Date:4/1/08 Signature:/s/ Christopher Mitchell Name:Christopher Mitchell Title:General Counsel Address:1310 Chesapeake TerraceSunnyvale, CA 94089 Telephone:(408) 789-4414 Date:4/1/08 10 ACCURAY EXHIBIT A SERVICES 1. Description of Services. Contractor will be present at and participate in VIP visits arranged by Company at Stanford University Medical Center (“SUMC”). In addition,Contractor will travel to and participate in both domestic and international sales visits as requested by Company. Finally, Contractor will travel to andparticipate in certain domestic tradeshows or symposiums which Company requests that Contractor attend. As soon as practicable following the execution ofthis Agreement, Contractor and the Company shall meet to schedule the specific Services to be performed during the first calendar quarter that this Agreementis in effect. Thereafter, Contractor and the Company shall meet at least thirty (30) days in advance of the end of each calendar quarter to schedule the Servicesto be performed during the subsequent calendar quarter. 2. VIP Visits. Contractor’s duties and deliverables in connection with Contractor’s participation in Company’s VIP visits at Accuray (up to two (2) visits permonth with a maximum of nine (9) visits per year) will include: 2.1 Question and Answer Sessions: Contractor will participate in a thirty (30) minute “Question and Answer” session during the VIP visit atAccuray. 2.2 Lunches/Dinners: Contractor will attend a lunch or dinner meeting, as applicable, following the VIP visit. 3. Sales Visits/Tradeshows/Symposiums. Contractor’s duties and deliverables in connection with Contractor’s travel to and participation in sales visits and tradeshows will include: 3.1 Domestic Sales Visits/Tradeshows/Symposiums: Contractor will travel to and attend domestic sales visits, tradeshows, and symposiums asrequested by Company, up to three (3) trips per year, with one (1) trips lasting two (2) days and two (2) trips lasting one (1) day. 3.2 Mexican and Canadian Sales Visits: One (1) trip per year to Canada or Mexico lasting for two (2) full days with customer. 11 ACCURAY 3.3 Europe and Emerging Market Sales Visits: Contractor will travel to and attend sales visits in Europe and other international emerging markets(for example, Canada, Mexico, Asia, and Latin America, or other miscellaneous emerging markets) as requested by Company. At Company’soption, these sales visits shall consist of: 3.3.1Two (2) trips per year to Europe. 3.3.2One (1) trip lasting four (4) days (two (2) full days with customer, the remaining days as travel). 3.3.3One (1) trip lasting five (5) days (three (3) full days with customer, the remaining days as travel). 3.3.4Two (2) trips per year to Asia lasting five (5) days (three (3) full days with customer, the remaining days as travel). 3.3.5One (1) trip per year to Latin America lasting five (5) days (three (3) full days with customer, the remaining days as travel). 4. Notice. To the extent possible, Company shall use commercially reasonable efforts to provide Contractor with at least three (3) weeks prior notice of anytravel required in connection with sales visits and attendance at trade shows and symposiums. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 12 ACCURAY EXHIBIT B COMPENSATION 1. Compensation. Contractor shall be compensated for Services performed according to this Agreement as follows: 1.1. Compensation for VIP Visits and webcast support: 1.1.1.Q & A Session:$650 per Q&A session 1.1.2.Lunch or Dinner:$650 per Lunch or Dinner 1.1.3.Webcast with Q&A$650 per session 1.1.4.Maximum Compensation:$1,300 1.1.5.Maximum Annual Compensation:$15,600 per year 1.1.6.Maximum annual compensation for VIP Visits is based on nine (9) VIP visits and six (6) webcasts per year withparticipation in case observation, Q&A Session and Lunch or Dinner at each VIP Visit. 1.2. Compensation for Attending Domestic Sales/Tradeshow/Symposium Visits: 1.2.1.One day Domestic Sales Visit/Tradeshow:$4,800 per visit 1.2.2.Two day Domestic Sales Visit/Tradeshow:$8,600 per visit 1.2.3.Maximum Annual Compensation:$18,200 per year 1.2.4.Maximum annual compensation for domestic sales visits, tradeshows, and symposiums is based on the maximumof two (2) one-day visits and one (1) two-day visit per year, such visits to be selected by the Company. 1.3. Compensation for Mexico and Canada Visits: 1.3.1.Two-day Sales Visit:$9,600 per visit 1.3.2.Maximum Annual Compensation:$9,600 per year 13 ACCURAY 1.3.3.Maximum annual compensation for Mexican or Canadian visits is based on the maximum of one (1) two-day visit,such visit to be selected by the Company. 1.3.4.Notwithstanding the forgoing, in the event Company requests that Contractor travel to and attend a Mexican orCanadian sales visit, tradeshow, or symposium without at least thirty (30) days prior notice, then Company shallpay contractor an additional $1,000 in addition to the applicable compensation set forth in this Section. 1.4. Compensation for Attending Europe and Emerging Market Sales Visits: 1.4.1.Four-day Sales Visit:$21,600 per visit 1.4.2.Five-day Sales Visit:$25,000 per visit 1.4.3.Maximum Annual Compensation:$123,700 per year 1.4.4.Maximum annual compensation for Europe and Emerging Markets Sales Visits is based on the maximum of one (1)trip lasting four (4) days to Europe, one (1) trip lasting five (5) days to Europe, two (2) trips lasting five (5) days toAsia, one (1) trip lasting five (5) days to Latin America, as set forth in §3.3 of Exhibit A. 1.4.5.Notwithstanding the forgoing, in the event Company requests that Contractor travel to and attend a European orEmerging Market sales visit, tradeshow, or symposium without at least 30 days prior notice, then Company shallpay contractor an additional $1,000 in addition to the applicable compensation set forth in this Section. 1.5. Total Compensation/Payment. As indicated above, Contractor’s maximum possible annual compensation from Company under thisAgreement is $167,100 to be paid quarterly in advance, in four (4) equal installments of $41,775 per quarter beginning on the day thatthis Agreement is signed by both Parties and thereafter on the first business day of each quarter. Should Contractor not perform certain ofthe above objectives, then future quarterly payments to Contractor may be offset by the corresponding amount of the Services notperformed. If at the end of the term of this Agreement, certain Services were not performed, and Contractor’s failure to perform suchservices has not been offset against any subsequent quarter’s installment, then Contractor shall reimburse Company for the correspondingamount of the services not performed within thirty (30) calendar days. 14 ACCURAY EXHIBIT C LIST OF POTENTIAL CONFLICTS Cyberheart Inc. 15 ACCURAY EXHIBIT DCONTRACTOR TIME RECORD Contractor: DateDescription of Services PerformedLocations of Services PerformedNumberof Days/Visits This record is a complete and accurate description of the Services I performed and the time spent in connection therewith on behalf of AccurayIncorporated on the dates specified above. ContractorDate 16QuickLinks -- Click here to rapidly navigate through this documentExhibit 21.1 Subsidiaries of the Registrant Name State or Jurisdiction of OrganizationAccuray International SARL SwitzerlandAccuray Europe SARL FranceAccuray UK, Ltd. United KingdomAccuray Asia Ltd. Hong KongAccuray Japan K.K. JapanAccuray Spain, S.L.U. SpainAccuray Medical Equipment (India) Private Limited. IndiaAccuray Medical Equipment (SEA) Private Limited. SingaporeQuickLinksExhibit 21.1Subsidiaries of the RegistrantQuickLinks -- Click here to rapidly navigate through this documentExhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have issued our reports dated September 5, 2008, with respect to the consolidated financial statements, schedule, and internal control overfinancial reporting included in the Annual Report of Accuray Incorporated on Form 10-K for the year ended June 30, 2008. We hereby consent to theincorporation by reference of said reports in the Registration Statements of Accuray Incorporated on Forms S-8 (File No. 333-141194, No. 333-141195, and No. 333-141197, effective March 9, 2007)./s/ GRANT THORNTON LLPSan Francisco, CaliforniaSeptember 5, 2008QuickLinksExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMQuickLinks -- Click here to rapidly navigate through this documentExhibit 31.1 Certifications I, Euan S. Thomson, Ph.D., certify that: 1. I have reviewed this report on Form 10-K of Accuray Incorporated, a Delaware corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered bythis report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects,the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as definedin Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared; b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles; c)evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusion about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d)disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's mostrecent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internalcontrol over financial reporting.Date: September 9, 2008 /s/ EUAN S. THOMSON, PH.D.Euan S. Thomson, Ph.D.President and Chief Executive OfficerQuickLinksExhibit 31.1CertificationsQuickLinks -- Click here to rapidly navigate through this documentExhibit 31.2 I, Robert E. McNamara, certify that: 1. I have reviewed this report on Form 10-K of Accuray Incorporated, a Delaware corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary tomake the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered bythis report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects,the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as definedin Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared; b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principles; c)evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusion about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d)disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's mostrecent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonablylikely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting,to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internalcontrol over financial reporting.Date: September 9, 2008 /s/ ROBERT E. MCNAMARARobert E. McNamaraSenior Vice President and Chief Financial OfficerQuickLinksExhibit 31.2QuickLinks -- Click here to rapidly navigate through this documentExhibit 32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Accuray Incorporated, aDelaware corporation (the "Company") hereby certifies, to such officer's knowledge, that: (i) the accompanying Annual Report on Form 10-K of the Company for the twelve months ended June 28, 2008 (the "Report") fullycomplies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of theCompany.Date: September 9, 2008 /s/ EUAN S. THOMSON, PH.D. Euan S. Thomson, Ph.D.President and Chief Executive Officer /s/ ROBERT E. MCNAMARA Robert E. McNamaraSenior Vice President and Chief Financial OfficerQuickLinksExhibit 32.1Certification of Chief Executive Officer and Chief Financial Officer

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