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US NEUROSURGICAL INC - 10-Q - Management Discussion and Analysis of Financial Condition and Results of Operations.

August 14, 2014

Critical Accounting Policies

The condensed consolidated financial statements of U.S. Neurosurgical, Inc. and subsidiaries ("USN" or the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America. As such, some accounting policies have a significant impact on amounts reported in the condensed consolidated financial statements. A summary of those significant accounting policies can be found in Note B to the Consolidated Financial Statements, in our 2013 Annual Report on Form 10-K. In particular, judgment is used in areas such as determining and assessing possible asset impairments and determination of the asset retirement obligation.

The following discussion and analysis provides information which the Company's management believes is relevant to an assessment and understanding of the Company's results of operations and financial condition. This discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere herein.

Results of Operation

Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013

Patient revenue and expenses for the three months ended June 30, 2014 were $737,000 and $204,000 respectively, compared to none the previous year due to the center being closed in 2013 as a result of the destruction of the NYU gamma knife facility in October 2012.

Selling, general and administrative expense of $309,000 for the second quarter of 2014 was 4% lower than the $322,000 incurred during the comparable period in 2013. The decrease in SG&A expenses was mostly due to lower audit expenses and a decrease in insurance costs.

The Company incurred $52,000 of interest expense in the second quarter of 2014 related to the new capital lease and the short term construction loan. There was no interest during the same period in 2013 as a result of the early payoff of the Company's previous capital lease due to the destruction of the gamma knife and related equipment and receipt of associated insurance proceeds in early 2013.

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Table of Contents During the three months ended June 30, 2014, the Company recognized a gain on sale of investments of $33,000 in settlement from the sale of its interest in BROP. There were no sales of investments during the three months ended June 30, 2013.

During the three months ended June 30, 2014, the Company did not recognize a provision for income taxes as compared to an income tax benefit of $112,000 for the same period a year earlier.

For the three months ended June 30, 2014, the Company reported a net income of $232,000 as compared to a net loss of $188,000 for the same period a year earlier.

Six months ended June 30, 2014 Compared to Six months ended June 30, 2013

Patient revenue and expenses for the six months ended June 30, 2014 were $737,000 and $204,000 respectively, compared to none the previous year due to the center being closed in 2013 as a result of the destruction of the NYU gamma knife facility in October 2012.

Selling, general and administrative expenses of $568,000 for the six months ended June 30, 2014 were 4% more than the $544,000 incurred during the comparable period in 2013. The increase in SG&A expenses was primarily due to an increase of expenses related to opening the new facility.

The Company incurred $65,000 in interest expense in the six months ended June 30, 2014 related to the new capital lease and the short term construction loans.

During the six months ended June 30, 2014, the Company recognized a gain on sale of investments of $238,000 from the sale of its interest in BOP and BROP. There were no sales of investments or settlement of past management fees during the six months ended June 30, 2013.

During the six months ended June 30, 2014, the Company did not recognize a provision for income taxes as compared to an income tax benefit of $196,000 for the same period a year earlier.

For the six months ended June 30, 2014, the Company reported a net income of $126,000 as compared to net loss of $327,000 for the same period a year earlier.

Liquidity and Capital Resources

At June 30, 2014, the Company had working capital of $589,000 as compared to $1,081,000 at December 31, 2013. This decrease was due to the cost of additional construction and leasehold improvements recorded in connection with the reopening of the Company's NYU gamma knife center. Cash and cash equivalents at June 30, 2014 were $1,094,000 as compared to $1,414,000 at December 31, 2013.

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Table of Contents Net cash used in operating activities for the six months ended June 30, 2014 was $660,000 as compared to $526,000 used in operating activities in the same period a year earlier. Accounts receivable increased $725,000 for the six months ended June 30, 2014 as compared to none the previous year due to the reopening of the NYU gamma knife facility.

With respect to investing activities, the Company sold its interest in BOP in the first quarter of 2014 for proceeds of $156,000 after allocation towards repayment of the Company's intercompany loans to BOP. The Company sold its interest in BROP in the second quarter of 2014 for proceeds of $100,000 after allocation towards repayment of the Company's intercompany loans to BROP. The Company received $3,265,000 in insurance proceeds related to the destruction of the NYU gamma knife during the previous year. Additionally, due from related parties of $311,000 were repaid primarily in connection with the sale of BOP and BROP compared to an increase in due from related parties of $222,000 the previous year. With respect to financing activities, the Company borrowed $462,000 in short-term loans from outside investors in the first quarter of 2014. The Company paid $2,271,000 towards its capital lease during the previous year.

Due to the disruption caused by the flooding from Hurricane Sandy, the Company did not receive revenues from the NYU facility until late April 2014 when the center reopened and began accepting patients for treatment.

The terms of the agreement with NYU remained the same, terminating at the end of March 2021. The Company entered into a six year lease in the amount of $4.6 million for the purchase of the replacement equipment. The first payment of $78,000 is due on September 1, 2014, and the final payment is due on May 1, 2020. The Company entered into a second two year lease in the amount of $250,000 for the cost of the construction required at the relocated site. The first payment of $12,000 is due on November 1, 2014, and the final payment is due on July 1, 2016.

Risk Factors

We desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. The following factors, as well as the factors listed under the caption "Risk Factors" in Annual Report on our Form 10-K for the fiscal year ended December 31, 2013, have affected or could affect our actual results and could cause such results to differ materially from those expressed in any forward-looking statements made by us. Investors should carefully consider these risks and speculative factors inherent in and affecting our business and an investment in our common stock.

Reliance on Business of the New York University Gamma Knife Center; Recent Destruction of Equipment and Discontinuation of Business at NYU. While it is the Company's objective to expand activities to additional cancer centers that rely on a broad range of diagnostic and radiation treatments, the Company has relied on the NYU gamma knife for substantially all of its revenue. In recent periods, services provided at NYU have represented over 90% of the Company's revenues. Unless and until the Company is successful in building its activities at other centers and at new locations, disruptions at NYU could have a materially adverse effect on the Company.

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Table of Contents In October 2012, the Company's facility at NYU was totally destroyed as a result of flooding from Hurricane Sandy. The gamma knife had to be removed to prevent cobalt leakage that might occur due to rusting of the equipment. While the Company reopened the facility in late April 2014, the facility was closed for approximately 18 months. It may take additional time to achieve and sustain the level of patient volume that the center was handling prior to the disruption.

The Company entered into a commitment for lease financing in the amount of $4.6 million for the purchase of the replacement equipment and for some construction and other costs associated with the damaged machine removal and new machine installation.

The Company anticipates that these factors may result in significant operating losses for the next several quarters.

Availability of Working Capital. To date, we have earned sufficient income from operations to fund periodic operating losses and support efforts to pursue new gamma knife or other types of cancer treatment centers. The Company expects to incur net cash outflows from operating activities for the next several quarters due to the destruction of the NYU Gamma Knife. Should net cash outflows continue for an extended period of time, or should the actual construction costs incurred materially exceed forecasts, we will be required to seek additional capital to support continued operations and the development of new centers, but we cannot assure you, however, that we will be able to raise such additional capital as and when required.

Disclosure Regarding Forward Looking Statements

The Securities and Exchange Commission encourages companies to disclose forward looking information so that investors can better understand a company's future prospects and make informed investment decisions. This document contains such "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements anticipating future growth in revenues and cash flow. Words such as "anticipates," "estimates," "expects," "projects," "targets," "intends," "plans," "believes," "will be," "will continue," "will likely result," and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify such forward-looking statements. Those forward-looking statements are based on management's present expectations about future events. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances, and the Company is under no obligation to (and expressly disclaims any such obligation to) update or alter its forward-looking statements whether as a result of such changes, new information, future events or otherwise.

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Table of Contents The Company operates in a highly competitive and rapidly changing environment and in businesses that are dependent on our ability to: achieve profitability; increase revenues; sustain our current level of operations; maintain satisfactory relations with business partners; attract and retain key personnel; maintain and expand our strategic alliances; and protect our intellectual property. The Company's actual results could differ materially from management's expectations because of changes in such factors. New risk factors can arise and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Investors should also be aware that while the Company might, from time to time, communicate with securities analysts, it is against the Company's policy to disclose to them any material non-public information or other confidential commercial information. Accordingly, investors should not assume that the Company agrees with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, the Company has a policy against issuing or confirming financial forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts or others contain any projections, forecasts or opinions, such reports are not the responsibility of the Company.

In addition, the Company's overall financial strategy, including growth in operations, maintaining financial ratios and strengthening the balance sheet, could be adversely affected by increased interest rates, construction delays or other transactions, economic slowdowns and changes in the Company's plans, strategies and intentions.


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