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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Commission File Number: 000-49867

CTI Molecular Imaging, Inc.

(865) 218-2000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value

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

      Indicate by check mark 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 registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.     þ

      Indicate by check mark, whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes o          No þ

      The aggregate market value of the common stock held by non-affiliates of the registrant was $666,327,906 as of December 2, 2002, based upon the last sale price of such stock as reported on the Nasdaq National Market on that day (assuming for purposes of this calculation, without conceding, that all executive officers and directors are affiliates). Because there was no public market for the common stock of the registrant as of the last business day of its most recently completed second fiscal quarter, the foregoing information is provided as of a recent date.

      There were 42,955,599 shares of common stock outstanding at December 2, 2002.

DOCUMENTS INCORPORATED BY REFERENCE

      Parts of the registrant’s proxy statement for its 2003 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.

Table of Contents

CTI MOLECULAR IMAGING, INC.

TABLE OF CONTENTS

Table of Contents

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

      This report contains “forward-looking statements.” Forward-looking statements relate to expectations, beliefs, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts or that necessarily depend upon future events. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential,” and similar expressions. Specifically, this report contains, among others, forward-looking statements about:

	•	our expectations regarding financial condition or results of operations for periods after September 30, 2002;
	•	our future sources of and needs for liquidity and capital resources;
	•	our critical accounting policies;
	•	the timing of the exercisability of the Siemens option to purchase an additional ownership interest in CTI PET Systems and the effect of the Siemens option, or its exercise, on our business;
	•	our expectations regarding the size and growth of the market for our products and services;
	•	our business strategies and our ability to grow our business;
	•	our ability to enhance existing, or develop new, products and services and the impact of any such enhancements or developments;
	•	the development of new applications for PET and the impact of any such new applications;
	•	the implementation or interpretation of current or future regulations and legislation;
	•	the number and scope of procedures involving our products and services for which third-party reimbursement is available, and the reimbursement levels of third-party payors;
	•	our ability to maintain contracts and relationships with key suppliers, customers, distributors or research and development collaboration partners; and
	•	our ability to maintain our existing, or to develop additional, valuable intellectual property rights.

      The forward-looking statements contained in this report reflect our current views about future events, are based on assumptions and are subject to known and unknown risks and uncertainties. Many important factors could cause actual results or achievements to differ materially from any future results or achievements expressed in or implied by our forward-looking statements. Many of the factors that will determine future events or achievements are beyond our ability to control or predict. Important factors that could cause actual results or achievements to differ materially from the results or achievements reflected in our forward-looking statements include, among other things, the factors discussed in Part II, Item 7 of this report under the sub-heading “Risk Factors.”

      You should read this report, the information incorporated by reference into this report and the documents filed as exhibits to this report completely and with the understanding that our actual future results or achievements may be materially different from what we expect or anticipate.

      The forward-looking statements contained in this report reflect our views and assumptions only as of the date this report is signed. Except as required by law, we assume no responsibility for updating any forward-looking statements.

      We qualify all of our forward-looking statements by these cautionary statements. In addition, with respect to all of our forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

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PART I

      For convenience in this annual report, “CTI,” “we,” “us,” and “the Company” refer to CTI Molecular Imaging, Inc. and our consolidated subsidiaries, taken as a whole.

Item 1.     Business

Overview

      We are a leading manufacturer of positron emission tomography imaging equipment and related products used in the detection and treatment of cancer, cardiac disease and neurological disorders. Positron emission tomography, or PET, is a medical imaging technology that images the biology of disorders at the molecular level before anatomical changes are visible. This allows physicians to diagnose and treat a broad range of diseases earlier and more accurately than other imaging technologies that focus on anatomic abnormalities. We provide the most complete and integrated product line for PET, including scanners, cyclotrons, radiopharmaceuticals, detector materials and support services. Our business model emphasizes our exclusive focus on PET, our ability to provide a “total solution” for our customers, our proprietary technology rights and our proven track record of technological innovation.

      PET scans allow physicians to view metabolic activity on a non-invasive basis using minute quantities of injected radioactive molecules. Procedures conducted with PET technology provide information that is not available from traditional imaging technologies such as X-ray, computed tomography, or CT, ultrasound and magnetic resonance imaging, or MRI, where changes in body structure or anatomy must occur before an abnormality can be detected. Unlike X-ray, CT, ultrasound and MRI, PET evaluates biological and biochemical processes that precede anatomical changes or lesions from disease, thereby enabling earlier detection of diseases such as cancer and neurological disorders. PET also offers advantages in the treatment of disease due to its ability to monitor the effects of therapy at the molecular level. Our combined PET/CT scanner, which we introduced commercially in November 2001, was selected by TIME Magazine as the medical science “Invention of the Year” in 2000. This scanner combines PET and CT technologies into one device that simultaneously reveals both metabolic processes and anatomical details within the body to improve image quality and localization of abnormalities as well as to guide biopsies, radiation therapy and surgical treatments.

      The market for PET products and services has recently experienced rapid growth, and we believe it will continue to grow rapidly, for the following reasons:

	•	the increasing number of PET procedures for which Medicare and private insurance reimbursement is available;
	•	increasing recognition by physicians of the clinical advantages of PET and an increasing number of PET providers;
	•	the expansion of PET applications beyond the diagnosis of disease and into the monitoring of disease therapy;
	•	the discovery of additional clinical applications for PET;
	•	the aging of the population and the growing number of patients with cancer, cardiac disease, neurological disorders and other diseases for which PET scans are performed;
	•	technological innovations involving PET that shorten scan times and improve imaging capabilities, such as the next generation of LSO-based scanners and the combined PET/CT scanner; and
	•	the increasing availability of the radiopharmaceuticals used in PET, as well as the development of new radiopharmaceuticals that extend PET technology to new applications.

      We believe we are well positioned to benefit from the anticipated growth in the PET market due to our “total solution” approach of offering health care providers a comprehensive line of the products and services necessary to incorporate the benefits of PET into their clinical settings. We manufacture and

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Industry Background

      The basis of PET imaging is the labeling of small, biologically important molecules, such as glucose, amino acids, pharmaceuticals or even water, with positron-emitting radionuclides that are injected into patients. These injected materials are referred to as radiopharmaceuticals. The radionuclides undergo radioactive decay, whereby their nuclei emit positrons that travel a very short distance in tissue before colliding with electrons, converting their total mass into detectable forms of energy. In the modern PET scanner, thousands of small detectors are oriented in a ring configuration surrounding the patient’s body. Computer reconstruction of the data acquired by these detectors permits a visual depiction of a metabolic process within cells of the organ systems of the body.

      In common applications relating to cancer, a few milliliters of a water-based solution containing a minute amount of sugar tagged with the radionuclide fluorine-18, known as F-18-fluorodeoxyglucose, or FDG, is injected into a patient. FDG is delivered throughout the body via the blood stream, and like natural sugar in the blood, FDG is taken into normal cells of organs as well as cancerous cells. Because many types of cancer cells use sugar and grow faster than normal cells, they consume FDG at a much higher rate than normal cells. The PET scanner produces an image of the consumption of FDG in cells of the organs and tissues throughout the body. Like many diseases, cancer is a metabolic abnormality. PET’s ability to image the metabolic process enables an earlier and more accurate diagnosis of the disease and monitoring of the effectiveness of therapy.

      Other promising applications for PET include cardiac disease and neurological disorders. In cardiology, PET images can be used to assess coronary artery disease (CAD) and left ventricular dysfunction. Physicians can use PET images to determine the presence and extent of heart disease and to assist in determining whether invasive procedures are necessary and will benefit the patient. In addition to examining blood flow to the heart, PET is used for patients with heart disease to determine whether cells of the heart are dead or alive. The use of PET prior to angioplasty and bypass surgery to assess the viability of heart tissue and the likelihood of a successful outcome could have significant cost advantages to payors by eliminating expensive, unnecessary revascularization procedures. PET has been useful scientifically with respect to neurological disorders such as Alzheimer’s disease, Parkinson’s disease, and epilepsy.

      The effective use of a PET scanner depends on a readily available supply of radiopharmaceuticals, which are very short lived, making local availability essential. Most clinically important radiopharmaceuticals are produced using a sophisticated piece of electronic equipment called a cyclotron, which requires specially trained technicians and a licensed special purpose facility. Historically, institutions performing PET scans required an on-site cyclotron to produce radiopharmaceuticals on demand. PET customers now have an alternative to installing and operating cyclotrons on-site by obtaining local distribution of radiopharmaceuticals from specialized pharmacy providers. We expect the market for radiopharmaceuticals to grow as the adoption and utilization of PET continues to grow and as new and more effective radiopharmaceuticals are developed for additional applications of PET technology.

      The most common medical imaging technologies in the U.S. today are X-ray, CT and MRI. These imaging technologies have several advantages over PET, namely they represent the current standard of patient care, provide clear anatomical images, generally are reimbursed, are fast (in the case of X-ray and CT) and today’s radiologists are very competent in reading these types of images. In comparison to CT

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      PET is fundamentally different from X-rays, MRI, ultrasound and CT technologies. With X-rays, CT, ultrasound and MRI, an abnormality must manifest itself as a change in body structure or anatomy, such as the development of a sizeable tumor, before it can be detected. PET, on the other hand, can, in many cases, identify diseases earlier and more specifically than X-rays, CT, ultrasound or MRI by detecting abnormalities in cellular activity that precede anatomical changes. In addition, unlike other imaging technologies, which merely confirm the presence of a mass, PET often enables physicians to distinguish between benign and malignant disorders or between living and dead tissue. PET can also be more effective in monitoring the treatment of disease. For example, treating cancer with chemotherapy leads to changes in cellular activity, including a decline in the consumption of sugar and FDG, that are observable by PET long before structural changes can be measured by X-rays, CT, MRI or ultrasound. Accordingly, PET can enable a physician to evaluate the efficacy of a prescribed treatment regimen, perhaps leading to a modification in treatment, before such an evaluation could be made using X-rays, CT, MRI or ultrasound.

      Sales of dedicated PET imaging equipment and related products and services have grown rapidly and are expected to continue growing rapidly. Dedicated PET imaging equipment refers to scanners that utilize PET imaging technology in isolation rather than in combination with another imaging technology such as the recently introduced PET/CT scanner. Based on a 2001 market analysis prepared by Frost & Sullivan, a marketing consulting firm, the estimated installed base of dedicated PET scanners in the U.S. grew from 107 in 1997 to 348 in 2000, and the estimated number of units shipped annually in the U.S. grew from 12 in 1997 to 160 in 2000. The Frost & Sullivan analysis forecasts that from 2000 through 2007 the U.S. installed base of dedicated PET scanners will grow at an estimated compound annual growth rate of 38.7%, and the number of units shipped in the U.S. will grow at an estimated compound annual growth rate of 22.0%.

      One of the principal reasons for growth in the PET market is the increasing number of PET applications being approved for reimbursement by third-party payors, such as Medicare, national and local private insurers and HMOs. Reimbursement is critical to increasing the adoption rate of PET by clinicians. Through active educational efforts, industry participants and associations, such as the Academy for Molecular Imaging, Society of Nuclear Medicine and the Radiological Society of North America as well as the National Institutes of Health, have been successful in increasing the awareness of PET’s benefits to patients, physicians and members of the payor community and in increasing the number of PET applications for which reimbursement is available. On July 1, 2001, the Centers for Medicare and Medicaid Services (CMS), which administers Medicare and Medicaid, expanded its policy to cover PET scanning in six oncology applications, two cardiac applications and one neurological application. Effective October 1, 2002, CMS expanded coverage for breast cancer and heart disease. The following table summarizes the PET applications that have been approved for reimbursement by CMS. As used in the following table, the term “staging” generally refers to the use of PET in the initial diagnosis process to verify the existence and status of the disease. The term “restaging” generally refers to the use of PET following, and in some instances during, the treatment process to determine the status of the disease and the effectiveness of the treatment regimen.

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Source: Section 50-36 of the CMS Coverage Manual and CMS Decision Memoranda #CAG-00094A and #CAG-00098N

      As the foregoing table suggests, the majority of PET scans today are performed for oncology procedures. According to the U.S. Centers for Disease Control, cancer is the second leading cause of death in the U.S., with one in four deaths in the U.S. related to cancer. Incidence of cancer increases with age. The number of Americans age 45-64 who will reach 65 over the next two decades increased by 34% during the past decade. We believe the utilization of PET in the oncology market will continue to grow due to the aging of the population, a corresponding increase in the number of patients with cancer and discoveries involving the use of PET in additional oncology applications as well as the expansion of reimbursement to additional cancer indications.

      We also expect new innovations involving PET. Research and development activities in the industry are focused on decreasing scan times, thereby increasing patient throughput capacity and improving patient comfort and image quality. For example, by using detectors made from lutetium oxyorthosilicate, or LSO, rather than the traditional detector material, bismuth germanate, or BGO, scan times for certain routine procedures have decreased from approximately 30 minutes to approximately ten minutes. Other research and development activities focused on improving image quality have recently resulted in the commercial

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      We also believe that research and development activities focused on the development of new radiopharmaceuticals may allow PET scanners to detect and monitor additional diseases which, in turn, could increase the number of recognized indications for PET.

Business Strategy

      Our business focuses on enabling diagnosis and therapy monitoring for cancer, cardiac disease and neurological disorders using molecular imaging technology. Our overall goal is to expand and integrate PET into standard clinical practice by delivering innovative “total solutions” that support adoption and use of PET technology. We intend to enhance our position as the leading provider of integrated PET products and services in order to capitalize on the rapidly growing molecular imaging market. To achieve this objective, we intend to pursue the following strategies:

      Increase Overall Utilization of PET Technology. We intend to stimulate increased utilization of PET procedures by:

	•	supporting efforts to increase the number and scope of PET procedures that are approved for reimbursement;
	•	educating physicians, patients, pharmaceutical companies and payors regarding the clinical advantages of PET;
	•	expanding the utilization of our PET scanners beyond diagnosis to managing the treatment of disease; and
	•	developing new applications for PET technology by supporting clinical trials that involve PET, collaborating with pharmaceutical companies and developing new radiopharmaceuticals.

      Continue Offering Customers a Comprehensive Line of Integrated PET Products and Services. We intend to emphasize our “total solutions” approach by offering a broad range of integrated products and services that complement our sophisticated PET imaging equipment in order to:

	•	better compete with larger imaging equipment companies that have a captive finance company to offer customers financing arrangements and price concessions for PET scanners but lack the full array of products and services a customer needs to operate a PET imaging business;
	•	offer products and services that are comprehensive yet individually tailored to meet the differing needs of a variety of customers in a variety of clinical settings;
	•	facilitate entry into the PET imaging business by offering new providers an integrated total solution of all products and services necessary to incorporate the benefits of PET into a clinical setting; and
	•	capture a greater share of PET-related expenditures as the market for PET imaging products and services continues to grow.

      Expand Our Direct Sales Force and Distribution Network. In order to capture a large portion of the anticipated growth in demand for PET scanners, we intend to enhance our sales and distribution capacity by:

	•	expanding our direct sales force, including the addition of CTI sales representatives in major U.S. metropolitan markets and adding dealers and distributors in key international markets; and
	•	pursuing a multiple distributor strategy for our PET scanner products through CTI PET Systems.

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      Continue to Build Our Production and Distribution Network for Radiopharmaceuticals. We intend to further expand our existing PETNET network of radiopharmaceutical production and distribution facilities in order to:

	•	seize “first mover” advantage by being the first PET radiopharmacy in targeted markets and leveraging our access to lower cost, self-manufactured cyclotrons;
	•	continue to grow our recurring revenue streams; and
	•	extend the reach of the PETNET radiopharmacy network and leverage this greater scale to achieve operating efficiencies and improve delivery time.

      Maintain Our Technological Leadership Through Focused Research and Development. We have been a leading innovator of PET technology, and through CTI PET Systems are dedicated to the development of next generation PET scanners in order to:

	•	take advantage of our exclusive right to use LSO in molecular imaging products to advance the state-of-the-art in PET scanners;
	•	improve image quality for better diagnosis and treatment of patients;
	•	shorten scan times for increased patient comfort and throughput capacity; and
	•	expand clinical applications of PET technology.

      Develop New Proprietary Radiopharmaceuticals. We intend to focus significant research and development efforts on our radiopharmaceuticals business, including efforts to:

	•	develop new varieties of radiopharmaceuticals to improve image quality, extend imaging capabilities to biological processes of additional organs and extend the use of PET imaging to additional diseases;
	•	collaborate with leading pharmaceutical companies and academic institutions to, among other things, improve their process for conducting research and clinical trials; and
	•	explore new therapeutic applications for PET.

Our Products and Services

      Our products and services can be broadly classified into four principal categories:

	•	PET and PET/CT scanners;
	•	detector material products;
	•	radiopharmaceuticals; and
	•	other PET products and services.

      Our subsidiary, CTI PET Systems, manages the development, manufacturing, distribution and sale of the ECAT® line of PET scanners. This line of scanners consists of stand-alone PET scanners and the combined PET/CT scanner. The scanner system consists of a scanner frame known as the gantry, a patient bed, an acquisition computer and a high-speed operator’s workstation. The ECAT® scanner line performs simultaneous acquisition, image reconstruction, processing, and data analysis, which enhances patient throughput and generates prompt results. The scanners produced by CTI PET Systems range in price from $800,000 to $2.5 million and offer customers a range of throughput times, resolution and image quality. With the variety in pricing and function, we are able to meet the needs of small and mid-sized imaging centers, as well as larger facilities that require more extensive equipment for clinical research purposes. For a discussion of segment financial information, see “Segments” in note 13 of the notes to our consolidated financial statements appearing elsewhere in this annual report.

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      We believe we are now the leading manufacturer of bismuth germanate, or BGO, detector material, the most widely used detector material in PET today.

      We also manufacture lutetium oxyorthosilicate, or LSO, as a detector material for use in our PET scanners. LSO is a lutetium based scintillator material the chemical compound of which was patented by Schlumberger Technology Corporation. By using LSO as a detector material in our products, we expect our scanners to provide improved performance and diagnostic accuracy by decreasing patient scan times and increasing image quality. We have exclusive rights to the development and manufacturing of LSO as a detector material. We acquired these exclusive rights from Schlumberger in February 1995. The rights terminate upon the expiration of Schlumberger’s patents for LSO, which are currently scheduled to expire in October 2008. While LSO is the only lutetium based scintillator material currently used in the PET industry, it may be possible for others to produce a lutetium based detector without violating the Schlumberger patent and, therefore, our exclusive license.

      The following table highlights the benefits of LSO versus BGO as a detector material in PET scanners:

      A fundamental tenet of the diagnostic PET imaging technique is the fact that the injection of the radioactive material does not interfere with or disrupt the natural state of the biological system. This means that PET radiopharmaceuticals do not cause a pharmacologic effect. Radiopharmaceuticals probe the molecular processes operative in living organisms. Radiopharmaceuticals are intended for use in the diagnosis or monitoring of diseases or manifestations of diseases.

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      Through our PETNET subsidiary, we currently operate 35 radiopharmaceutical production and distribution centers, referred to as PETNET radiopharmacies, located in major metropolitan areas across the U.S. and one radiopharmaceutical production and distribution center in the United Kingdom. Of our 36 radiopharmacies, we operate 12 cyclotrons owned by others, or hosts, pursuant to contracts. Our PETNET radiopharmacies principally produce and distribute FDG, which is used in oncology, cardiology and neurology applications. Our PETNET radiopharmacies allow customers to obtain a cost effective source of radiopharmaceuticals without having to purchase and operate their own cyclotron. In addition, our nationwide network of distribution centers provides our customers with assurance that their radiopharmaceutical requirements will be satisfied in a timely manner that reduces scanner downtime and facilitates patient scheduling. We also provide various PET-related services through PETNET, including reimbursement education, radiation safety consulting, licensure assistance and marketing assistance. We believe that the demand for radiopharmaceuticals will expand with the future growth of the PET market and the growing demand for PET services. To meet this demand, we expect to continue the expansion of our PETNET network.

      Cyclotron Systems. We produce cyclotrons for the production of radiopharmaceuticals at our PETNET radiopharmacies and for sale to hospitals and imaging centers that choose to manufacture radiopharmaceuticals for themselves. Our cyclotrons provide a cost-effective, easy-to-operate, self-shielded, and automated system that produces positron-emitting radionuclides and compounds used in making radiopharmaceuticals such as FDG. We developed these systems to improve efficiency and lower cost while maintaining high levels of performance, improved production capacity, automated operation, and a complete line of automated chemistry modules. Our cyclotrons combine high beam quality and shielding with efficiencies in space requirements, building modifications and operating costs. In 2001, we introduced a new high performance cyclotron with 100% more production capacity than our previous model, while maintaining its cost-effective, self-shielded design. Currently, we offer three cyclotron models: the ECLIPSE ST, which is designed for hospital use, ECLIPSE RD, which is configured for research use, and the ECLIPSE HP, which is built for high-yield commercial use. Each of our cyclotron systems can be upgraded to meet the needs of our customers as their business develops.

      Reveal Network Solutions. We have introduced an Internet-based product called the Reveal Network Solutions to connect physicians, PETNET radiopharmacies and patients to PET providers. The Reveal Network Solutions will facilitate the sharing of relevant information among users, thereby improving efficiency by automating some aspects of the PET process. The Reveal Network Solutions can be used to schedule imaging procedures and to obtain information regarding reimbursement. We expect this network to increase the efficiency of our PETNET radiopharmacies by allowing PET facilities or hospitals to order radiopharmaceuticals on line as opposed to ordering by facsimile or phone. Further, the Reveal Network Solutions will provide us with an on-line method to educate physicians regarding the clinical advantages of PET.

      Additional Products and Services. Establishing, operating and maintaining a facility to conduct molecular imaging procedures requires more than purchasing a molecular imaging scanner. Our customers face challenges ranging from designing their facility to educating referring physicians and imaging technologists in the operation of the scanner. Our extensive experience in the molecular imaging industry allows us to help our customers through this process by offering a broad range of services. These include:

Repair and Maintenance Services. We offer our customers the opportunity to enter into long term service contracts with us pursuant to which we agree to provide repair and maintenance services, including scheduled preventive maintenance, troubleshooting and problem diagnosis, service and repair procedures and replacement parts installation. Of the approximately 275 PET scanners sold by us in the U.S., 130 are under contract for repair and maintenance services at an average price of $118,000 per year.

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	Site Planning and Installation Services. Prior to installing a PET scanner, we assist our customers with the development of their sites by providing pre-installation site inspections, consultation with facility architects, construction management services, system requirement and specification development and development of site planning documentation. Once a site is completed, we will then provide installation services including transporting the system to the facility, connecting all subsystems, completing the system start-up and safety check and conducting the initial performance testing.
	Radioactive Materials Licensing. A radioactive materials license is required to operate a molecular imaging center. Gathering the forms and information needed for the license application is a lengthy and cumbersome process. We work with our customers to collect the necessary information and then prepare the license application for submission. Once submitted, we track the progress of the application until it is received from the applicable state agency.
	Technologist Recruiting and Training. The day-to-day responsibilities for operating a molecular imaging scanner and interacting with patients are generally handled by a molecular imaging technologist. As a result of our extensive contacts in the molecular imaging industry, we have the capability to help our customers recruit and hire these technologists. Once hired, we can also provide them with additional training.
	Physician Training. We have a preceptorship program in operation at several facilities to train physicians in the details of PET imaging. We arrange for the physician to attend these courses. This training allows the physician to gain hands-on experience in an operational molecular imaging facility. The preceptorships typically last five days and include continuing medical education credits.
	Telephone Support. We also provide our customers access to a telephone support, or “help desk,” hotline where we have service personnel standing by to assist our customers with questions related the operation of our products. This hotline can also be used to order spare parts and request emergency on site assistance.
	Calibration Sources. Through our subsidiary, CTI Services, Inc., we produce the radioactive source rods used to calibrate our ECAT® scanners. All dedicated PET scanners require transmission sources as well as calibration sources. These sources are used by CTI PET Systems to evaluate newly manufactured scanners and we also sell replacement sources to the end users, generally through the scanner distributors.

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Research & Development

      Our founders and directors are recognized leaders in the development of PET technology. For example, our executive officer and director, Ronald Nutt, Ph.D., has been credited with co-developing the combined PET/CT and our director, Michael Phelps, Ph.D., one of the original inventors of the PET scanner, is a leading academic figure in PET. As a result of their leadership, we have been responsible for the development of many of the major commercial innovations in PET since our formation in 1983. The following table highlights some of these innovations:

      Our research and development team focuses on developing the next generation of PET scanners, cyclotrons and radiopharmaceuticals. In addition to our internal ideas, our research and development department collaborates with a network of leading physicians, academic imaging experts and, in the case of CTI PET Systems, with Siemens. We actively involve scientists and physicians during the research and development process in order to produce products that are truly customer driven and customer focused. We incurred $21.7 million in 2002, $19.0 million in 2001 and $14.9 million in 2000 in research and development expenses, including clinical and regulatory expenses.

      In order to enhance our research capabilities, we have also entered into collaboration arrangements with a number of universities and research institutions. For example, in 1994 we entered into a collaboration agreement with UCLA for the development of new molecular imaging technology. This relationship has led to a number of breakthrough developments in molecular imaging, from imaging the expression of genes to the development of new experimental radiopharmaceuticals. For example, our image of Alzheimer’s-related plaques using a new radiopharmaceutical was selected as the image of the year in 2001 by the Society of Nuclear Medicine. CTI PET Systems also worked with Dr. David Townsend at the University of Geneva to develop the PET/CT, which was recognized by TIME Magazine as the medical science “Invention of the Year” in 2000. Further, CTI PET Systems worked with the Max Planck Institute in Germany to develop the first large field of view clinical scanner in 1990 and, more recently, a 2mm brain scanner. These collaboration arrangements have increased our access to world-class physicians and scientists and have given us a platform to expand our name recognition in the scientific and medical communities and to increase understanding among physicians of the benefits of PET.

      Our role as a leader in the area of research and development is exemplified by the academic and research institutions that use our products. Today, our products are used by many of the leading medical and scientific institutions including The Cleveland Clinic, Columbia Presbyterian, Emory University, Washington University in St. Louis, Baylor University, UCLA, MD Anderson Cancer Center, Hospital

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Products Under Development

      CTI PET Systems is developing a next generation of dedicated PET scanners that use our advanced LSO-based detector systems. The next generation of scanners is expected to provide substantially higher patient throughput while providing improved image quality, a larger field of view and upgradeable performance. CTI PET Systems is also developing the next generation of PET/CT scanners that will incorporate advanced LSO-based detector systems. This next generation PET/CT is expected to better integrate PET and CT and is anticipated to substantially decrease body scan time to be consistent with the scan times of a CT while improving image quality.

      We are also expending significant resources in the development of the next generation of commercially available radiopharmaceuticals. Through this development process, we hope to expand the number of PET indications by, among other things, creating new proprietary radiopharmaceuticals that will allow PET to diagnose and manage an increasing number of diseases and to produce a closer alignment between molecular imaging of disease with PET radiopharmaceuticals and the treatment of disease with pharmaceuticals. Currently, we are working on the development of new radiopharmaceuticals to enhance the ability of PET to detect disorders such as inflammation, breast cancer, prostate cancer, Parkinson’s disease and Alzheimer’s disease.

      In order to further enhance our role as a leader in developing new PET technology and radiopharmaceuticals, PETNET has established a collaborative research and development facility with the UCLA School of Medicine. We refer to this new facility as the LA Tech Center. One of the goals of the LA Tech Center is to expand the use of PET technology to accelerate the drug development process. We believe PET has a number of advantages over other imaging modalities that will allow pharmaceutical companies to use PET to more quickly identify whether their developmental drugs are reaching their intended targets and achieving the desired therapeutic results. We anticipate that the use of PET by pharmaceutical companies could help to improve their success rate in clinical trials and speed up the drug development process. In addition, by expanding the use of PET in the drug development process, we hope to increase awareness in the medical community of the significant benefits of PET in identifying and measuring the progression of diseases.

Our Relationship with Siemens

      In 1987 we entered into a joint venture agreement with Siemens Medical Solutions USA, Inc., a wholly owned subsidiary of Siemens AG, pursuant to which Siemens acquired 49.9% of the outstanding capital stock of our subsidiary, CTI PET Systems. The cash consideration paid by Siemens for its 49.9% interest was paid directly to the individual shareholders of CTI PET Systems. The amount of the consideration, and the determination of the ownership percentage acquired by Siemens, was negotiated at arm’s length between Siemens and the shareholders of CTI PET Systems. Neither Siemens nor any of its affiliates has any ongoing financial obligations, commitments or guarantees with respect to CTI PET Systems related to the formation or operation of the joint venture. We entered into the joint venture agreement in order to provide us with access to Siemens’ global distribution network and to include our scanners in its product line.

      Put/Call Provision. The joint venture agreement contains, among other things, a put/call provision pursuant to which Siemens has the right to acquire from us for cash up to that number of shares of CTI PET Systems common stock necessary to bring Siemens’ aggregate ownership interest in CTI PET Systems to 80%. We refer to this as the call right. The call right becomes exercisable upon CTI PET Systems exceeding certain PET scanner unit sales volumes, as described below. Upon an exercise by Siemens of the call right, we have a one-time right to defer the sale for a period of one year. Upon CTI PET Systems exceeding the same minimum unit sales volumes, we have a right to require Siemens to

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      The exercisability of the put/call right is contingent upon CTI PET Systems selling, during the year preceding exercise, in excess of the cumulative total number of units specified in the “Siemens minima plus 20% plan” attached to the joint venture agreement. The “Siemens minima plus 20% plan” provides for annual increases in the cumulative total number of units sold by CTI PET Systems beginning on December 9, 1987. As of September 30, 2002, the cumulative total number of units sold by CTI PET Systems was 522 and CTI PET Systems would need to have sold a cumulative total of 907 units to achieve the required cumulative sales level for the put/call right to be exercisable. After 2002 the cumulative unit sales requirement increases by 74 units each year. It is impossible to definitively state when the put/call right will become exercisable by either party. However, based upon our current forecasts, we believe that the minimum sales volumes are not likely to be met before 2005.

      Upon exercise of either the put or the call, the joint venture agreement provides that the parties will attempt to negotiate the price to be paid for the CTI PET Systems shares. In the event the parties are unable to agree upon the price within 60 days, the price will be determined through an appraisal process with each party obtaining a valuation of the CTI PET Systems shares by an independent professional experienced in the valuation of closely held corporations similar to CTI PET Systems. If the valuations that are obtained are within 20% of each other, the price to be paid for the CTI PET Systems shares will be the average of the two valuations. If the difference between the valuations is more than 20%, the two appraisers will select another independent appraiser to provide a third valuation. In this case, the price to be paid for the CTI PET Systems shares will be the average of the two valuations that are the closest to each other.

      If the put/call right is exercised and Siemens’ aggregate ownership interest in CTI PET Systems increases to 80%, Siemens will then be able to effect a merger of CTI PET Systems with another Siemens-controlled entity and acquire the remaining 20% from us. Siemens will only be required to pay us either a negotiated price for the remaining 20% or, if we and Siemens are unable to agree, the fair value of the shares as determined in accordance with applicable provisions of the Tennessee General Corporation Act. In the event Siemens acquires a controlling interest in CTI PET Systems, CTI will no longer include CTI PET Systems in its consolidated financial statements.

      Use of Proceeds from Sale. If the put/call right is exercised, we will have broad discretion with respect to the use of the proceeds received from Siemens in connection with our sale of the shares of CTI PET Systems. We anticipate that we will evaluate appropriate alternatives as we approach the cumulative totals. Possible uses of the proceeds include the repayment of debt, strategic acquisitions, investment in product development and repurchase of a portion of our outstanding shares.

      Distributions. The joint venture agreement does not provide for any mandatory dividends or distributions by CTI PET Systems to us or to Siemens. Since the formation of the joint venture, CTI PET Systems has not paid any dividends or made any distributions on its capital stock. Payment of future dividends or distributions, if any, on the capital stock of CTI PET Systems would be at the discretion of the CTI PET Systems board of directors.

      Non-Competition Agreement. The joint venture agreement contains covenants not to compete which will prohibit us from participating in or owning an interest in any business that develops, sells or manufactures products that compete with the products offered by CTI PET Systems. This non-compete provision will remain in effect for a period of three years following the sale of our shares of CTI PET Systems pursuant to the exercise of the put/call right. Siemens is subject to a substantially similar covenant not to compete, which will also remain in effect following the exercise of the put/call right.

      Ownership of Intellectual Property and Other Assets. Following an exercise of the put/call right, Siemens will acquire control of CTI PET Systems and will therefore control the rights to the patents and other intellectual property then held by CTI PET Systems. These patents cover various electronics,

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      LSO Supply Arrangements. During the term of an existing sublicense agreement between us and CTI PET Systems, we are obligated to sell LSO-based products to CTI PET Systems on terms more favorable than we sell such products to any other party. However, we are not restricted from selling LSO to a competitor of CTI PET Systems. This sublicense automatically terminates upon the termination of our current LSO license, which expires in October 2008.

      Governance of CTI PET Systems and CTI. The joint venture agreement grants various rights to Siemens regarding the governance of CTI PET Systems, including the right to:

	•	designate two members of the five member board of directors of CTI PET Systems (we also have the right to designate two members of the CTI PET Systems board);
	•	select the fifth director of CTI PET Systems from a list of candidates that we submit to Siemens; and
	•	nominate one individual to serve as either the chairman of the board of directors or the president of CTI PET Systems with the appointment to the specific office to be at the discretion of the board.

      We have also agreed that for so long as we and Siemens each own more than 20% of the outstanding shares of CTI PET Systems, our board of directors will nominate a representative of Siemens, chosen by Siemens, to serve as a member of our board of directors. Several of our stockholders, who collectively own an aggregate of 38.8% of the outstanding shares of our common stock, have agreed to vote in favor of the Siemens’ nominee. Currently, Bernd Haetzel is the nominee selected by Siemens to serve on our board of directors.

      The joint venture agreement also contains provisions for the orderly and prompt resolution of disputes among the parties. In the fifteen years since the formation of the joint venture, the parties have only elected to avail themselves of the dispute resolution procedures twice. Most recently, the process was used to address a contract interpretation issue with respect to the implementation of the multiple distributor strategy. A favorable resolution was reached that has led to the expansion of our sales and marketing force for the distribution of products manufactured by CTI PET Systems. Additionally, this process has resulted in the signing of a number of new long-term contracts with Siemens and increased joint projects with Siemens on several new initiatives, including the development of the next generation PET/CT.

      Intercompany Services between CTI PET Systems and CTI. We have entered into an administrative services agreement with CTI PET Systems pursuant to which we provide certain administrative services to CTI PET Systems. Currently we provide CTI PET Systems with human resources services, information technology services, facilities support and maintenance services, regulatory services and various other corporate services. We also allow employees of CTI PET Systems to participate in certain of our employee benefit programs, including our stock option plan.

      Changes due to Multiple Distributor Strategy. Prior to the implementation of the multiple distributor strategy, CTI’s senior officers also served as senior officers of CTI PET Systems in similar capacities. Given the growth of our business and the transition to the use of multiple distributors, we have agreed with Siemens that we will appoint separate officers to serve each entity. Accordingly, effective October 1, 2002, Dr. Nutt resigned as CTI’s Senior Vice President and Technology Director. Dr. Nutt will continue to serve as the President of CTI PET Systems and as a member of CTI’s board of directors. In addition, Michael Templin resigned as an officer of CTI. Mr. Templin will continue to serve as the Chief Financial Officer of CTI PET Systems. We currently anticipate that Dr. Nutt will resign as President of CTI PET

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      CTI PET Systems has implemented other changes in connection with the transition to the use of multiple distributors, including the adoption of policies and procedures to protect the confidential information of its distributors and the elimination of its sales force.

      Siemens served as our exclusive distributor of ECAT® scanners from 1987 to 1997. From 1997 until 2001, Siemens and CTI PET Systems served as the only distributors of ECAT® scanners. In 2001, CTI PET Systems adopted a multiple distributor strategy in order to expand its distribution channel. As a result, we are now serving as a direct distributor of the products manufactured by CTI PET Systems. Our distribution agreement with CTI PET Systems grants us a non-exclusive worldwide right to distribute PET scanners manufactured by CTI PET Systems. Pursuant to the terms of our distribution agreement, CTI PET Systems has an obligation to sell scanners to us at a price that is no less favorable than the price offered by CTI PET Systems to any of its other distributors based on comparable volumes. In connection with this new multiple distributor strategy, CTI PET Systems also entered into a new distribution agreement with Siemens that contained terms that are substantially similar to the terms of our agreement.

      As a result of our new distribution agreement with CTI PET Systems, we anticipate that following the exercise of the put/call right we will continue to have a right to distribute PET products manufactured by CTI PET Systems through at least 2010. During the term of our distribution agreement, we will have access to new products developed by CTI PET Systems on the same terms and conditions that CTI PET Systems grants distribution rights to Siemens.

      Pursuant to the terms of our revolving credit facility with SunTrust Bank, CTI PET Systems is allowed to borrow up to $55.0 million under the credit facility to finance its operations. At September 30, 2002, CTI PET Systems did not have an outstanding balance under the credit facility. CTI PET Systems pays its pro rata portion of all fees and commissions under this credit facility. Our subsidiaries guarantee all obligations under the credit facility, except that the guarantee by CTI PET Systems is limited to $55.0 million and does not include any advances under the credit facility that are loaned (on an intercompany basis) to our PETNET subsidiary. The credit facility and the obligations of our subsidiary guarantors under the credit facility are secured by a lien on substantially all of our assets (including the capital stock or other forms of ownership interests we hold in our subsidiaries) and the assets of our subsidiary guarantors, except that the lien securing the guarantee of CTI PET Systems is principally limited to the accounts receivable and inventory of CTI PET Systems.

      In addition to the relationships previously discussed, we have entered into various other commercial arrangements with Siemens. For example, Siemens and CTI PET Systems recently entered into an agreement pursuant to which Siemens agreed to supply CTI PET Systems with CT scanners for the purpose of manufacturing a combined PET/CT scanner. Siemens has also agreed to provide us with replacement parts, training and other support for the CT scanners incorporated into the combined PET/CT systems. CTI PET Systems also has a license to use Siemens’ syngo® software which is an important component of the operating system for the PET/CT.

Competition

      The primary competitive factors in the PET equipment market are quality, technical capability, breadth of product line, distribution capabilities, price, the ability to offer vendor financing, and the ability to provide quality service and support. Our principal competition in the market for PET scanners comes

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      We believe the primary competitive factors in the radiopharmaceutical market are national distribution capabilities, reliability of delivery, price, the ability to develop new radiopharmaceuticals and the ability to obtain proprietary rights to any newly developed radiopharmaceuticals and cyclotron technology. In the radiopharmaceutical market, we have three principal groups of competitors. The first group consists of national radiopharmacy companies such as Amersham, Tyco, Syncor and Ion Beam Applications (and its subsidiary, Eastern Isotopes). The second group consists of independent regional radiopharmacy companies such as Geodax and Pharmalogic. The third group of competitors consists of large academic institutions. Setting up a radiopharmacy is capital intensive, involving a significant up-front investment. In addition, the first entrant in a given geographic market often benefits from the ability to establish relationships with key customers without significant competition. These factors can make it advantageous to be the first radiopharmacy, or “first mover,” in a given market. We were the first FDG distributor to enter many of the markets serviced by our network of 36 radiopharmacies. We believe this “first mover” advantage provides us some competitive advantage over other companies that might attempt to enter, or expand their presence in, the radiopharmaceutical markets we already serve. Currently, we estimate that no other single competitor has more than ten radiopharmacies containing cyclotrons that produce and distribute FDG.

      In the cyclotron business, the primary competitive factors are distribution capabilities, effective shielding design, quality, production capacity and automated production capability. We believe our position as a leader in developing cyclotron technology combined with our integrated product line will help us to compete in the cyclotron market.

Sales and Marketing

      Our sales and marketing efforts are focused on two primary segments of the PET market. The first segment includes hospitals, universities and other research institutions. The second segment includes customers such as freestanding imaging centers and cancer treatment centers, often owned by physicians and other entrepreneurs, who we believe are particularly well suited to benefit from our ability to offer a complete, integrated line of PET products and services. In order to effectively target each of these segments, CTI PET Systems recently implemented a multiple distributor strategy for scanners. Through a distribution arrangement with Siemens, we are able to leverage Siemens’ large sales and marketing force to sell dedicated PET scanners and combined PET/CT scanners to hospitals and research institutions. As a direct distributor of ECAT® scanners, we target customers whom we believe would particularly benefit from our integrated line of PET products and services. As a direct distributor of CTI PET Systems’ products, we have also entered into sub-distribution agreements in certain international markets in an effort to sell more ECAT® scanners abroad and in order to provide us access to new markets in which to sell our other PET products and services.

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      Our marketing and sales strategy emphasizes our complete and integrated line of PET related products and services, including PET scanners, radiopharmaceuticals, cyclotrons and services such as physician training and facility planning and design. Unlike many of our competitors who focus on limited aspects of the PET market, our sales and marketing team is able to present CTI as a single source for all PET related needs. In order to implement this strategy, which we call the “total solutions” approach, sales personnel from each of our business segments work together with prospective customers to develop a customized package of products and services.

      Our recent success in assisting the Thompson Cancer Center, a Knoxville, Tennessee based cancer center, offers a good example of our “total solutions” approach. Through the combined efforts of a multi-disciplinary team, we designed and implemented a comprehensive, customized solution for the development and operation of the Thompson Cancer Center’s new PET center. Our service organization assisted the center with the design and installation of the facility. Upon completion of the design and construction phase, the center acquired an ECAT® scanner manufactured by CTI PET Systems and today PETNET provides the center with all of its PET related radiopharmaceutical requirements.

      For fiscal years 2002, 2001 and 2000, our revenues from U.S. sales were $197.7 million, $144.7 million and $92.8 million, respectively. For fiscal years 2002, 2001 and 2000, our revenues from sales outside the U.S. were $60.7 million, $44.2 million and $31.2 million, respectively. Sales through Siemens represented approximately 49.6% of our consolidated revenues for the fiscal year ended September 30, 2002. We have no other single third-party customer that accounts for more than 10% of our sales.

      Firm backlog orders at September 30, 2002 and September 30, 2001 were $112.2 million and $109.6 million, respectively. A majority of this backlog is expected to be realized as revenues by the end of 2003.

Customer Service and Support

      Due to the anticipated growth in our business, we are in the process of expanding our customer service and support staff. We maintain a network of more than 90 service engineers and customer support specialists who provide installation, warranty, repair, training and support services for our products. We generate service revenue by providing service to customers on a time-and-materials basis and through comprehensive service contracts and the sale of parts.

      In our capacity as a direct distributor of CTI PET Systems products, we warrant ECAT® scanners against recurring and significant failures for a period of twelve months. We also warrant our cyclotrons for a period of twelve months. We offer a variety of post-warranty equipment service agreements and software support agreements that permit customers to contract for the level of equipment maintenance and software support they require.

      We believe customer service and support are an integral part of our competitive strategy. Service capability, availability and responsiveness play an important role in marketing and selling medical equipment and systems, particularly as the technological complexity of the products increases. Nevertheless, many hospitals use their own biomedical engineering departments or independent service organizations to service equipment after the warranty period expires. Therefore, we cannot depend on the conversion of all customers to service contracts after the expiration of warranty periods.

Intellectual Property

      Our future growth and ability to compete in the molecular imaging market are substantially dependent on internally developed technologies. We seek to protect our technology through a combination of copyright, patent, trademark, trade secret and other intellectual property laws. As of September 30, 2002, we held 27 U.S. patents and have 17 patent applications pending, which are generally related to our PET scanners, cyclotrons and radiopharmaceutical production. We believe it could take up to four years, and possibly longer, for our pending U.S. patent applications to result in issued patents. Certain

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      In addition to developing our own technology, we have entered into several license agreements to use third-party technology. For example, we have an exclusive worldwide license from Schlumberger Technology Corporation to use the LSO technology. This license expires upon the expiration of the LSO patents, which are expected to expire in October 2008. We have sublicensed to CTI PET Systems and Concorde Microsystems, Inc. the right to use the LSO technology until such time as the License Agreement between CTI and Schlumberger has expired.

Manufacturing

      CTI PET Systems assembles ECAT® scanners, and we assemble cyclotrons, from components manufactured by us and components supplied to us by suppliers to whom we have outsourced portions of our manufacturing process. For ECAT® scanners, the most significant internal manufacturing process involves the production of detector materials, which includes several proprietary processes. Examples of components manufactured on an outsourced basis include circuit boards, wiring harnesses, computer hardware, mechanical gantries and patient couches. Outsourced components are either standard products or are manufactured according to our specifications. Typically, outsourced components that are manufactured according to our specifications are tested by the outsource manufacturer using test systems designed and supplied by our engineers and manufacturing staff. Each major outsourced component has an assigned outsource manager from our manufacturing staff. We use ongoing periodic inspection to help us monitor whether our outsource manufacturers are continuing to meet our quality standards. We believe that outsourcing enables us to reduce fixed costs and capital expenditures while also providing us with the flexibility to increase production capacity.

      A number of components used in our existing products, as well as products under development, are purchased from single sources. For example, we purchase a substantial portion of the raw material used to create our LSO detector material from a single source. In addition, while we do manufacture LSO detector material internally, our internal production capacity does not meet all of our requirements. We obtain the balance of our LSO requirements from a single supplier. Disruptions or loss of supply from any of our single source suppliers could disrupt our manufacturing process or cause significant unanticipated costs in obtaining alternative components or in incorporating alternative components into our production process.

      Our facility and quality system is inspected by TÜV Essen, which is an independent auditing firm responsible for granting accreditations of European Union Medical devices and quality assurance systems. Our facility and quality assurance systems have been found by TÜV Essen to conform to the requirements of ISO-9001, ISO 13485 and the European Union Medical Device Directive.

Government Regulation

      Our business is subject to many governmental and regulatory requirements relating to health care matters. We believe our current arrangements and practices are in material compliance with applicable statutes and regulations. However, we have not received or requested legal opinions from counsel or from any federal or state regulatory authority to this effect, and many aspects of our business operations have not been the subject of federal or state regulatory interpretation. As a result, we can not assure you that our current or prior practices or arrangements will not be found to be in compliance with applicable laws and regulations, and any such noncompliance could result in a material adverse effect to us.

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      We are subject to licensing and regulation under multiple federal and state laws, including laws relating to the use and handling of radioactive materials and laws relating to the operation of pharmacies. We also are required to register with the appropriate state agencies our radioactive sealed sources and each cyclotron that we own and operate. In addition, some states require us to obtain a reciprocity license before delivering products or servicing machines utilizing radioactive materials in those states. The pharmacists operating in the PETNET sites must be licensed, and many states require imaging technologists that operate PET systems to be licensed. We believe our operations are in material compliance with applicable federal and state licensure laws and regulations. Nevertheless, there can be no assurance that our current or past operations would be deemed to be in compliance with applicable laws and regulations, and any noncompliance could result in a material adverse effect on us.

      In some states, a certificate of need or similar regulatory approval is required prior to the acquisition of high-cost capital items or services, including diagnostic imaging systems or provision of diagnostic imaging services by our clients. Certificate of need regulations may limit or preclude our clients from providing diagnostic imaging services or systems. At present, a number of states in which we sell PET systems have certificate of need laws that restrict the supply of PET systems and other types of advanced medical equipment. Certificate of need laws were enacted to contain rising health care costs, prevent the unnecessary duplication of health resources, and increase patient access for health services. In practice, certificate of need laws have prevented hospitals and other providers who have been unable to obtain a certificate of need from acquiring new machines or offering new services. A significant increase in the number of states regulating our business through certificate of need or similar programs could adversely affect us.

      Numerous governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies, strictly regulate our products and research and development activities. The Federal Food, Drug, and Cosmetic Act, the regulations promulgated under this act, and other federal and state statutes and regulations, govern, among other things, the pre-clinical and clinical testing, design, manufacture, safety, efficacy, labeling, storage, record keeping and reporting, advertising and promotion of medical devices.

      Devices. Generally, before we can market a new medical device, we must obtain marketing clearance through 510(k) premarket notification. The FDA will typically grant a 510(k) clearance if we can establish that the device is substantially equivalent to a predicate device. It generally takes us several months from the date of a 510(k) submission to obtain clearance, but it may take longer, particularly if a clinical trial is required. We have obtained 510(k) clearance covering our PET scanners for use in a broad range of PET imaging applications for the purpose of determining various metabolic (molecular) and physiologic functions in humans. This general clearance covers diagnostic applications and applications for monitoring the treatment of disease.

      The FDA generally requires premarket approval for a medical device that does not have a predicate device. The FDA will typically grant a premarket approval if a sponsor provides valid scientific evidence that establishes the safety and effectiveness of the device. We do not anticipate that a premarket approval will be required for any of the PET scanners we develop in the foreseeable future.

      If human clinical trials of a device are required for a 510(k) submission and the device presents a significant risk to the patient in the trial, the sponsor of the trial, usually the manufacturer or the distributor of the device, must file an investigational device exemption application prior to commencing human clinical trials. The investigational device exemption application must be supported by data, typically including the results of animal and/or laboratory testing. If the investigational device exemption is allowed to go forward by the FDA and one or more appropriate institutional review boards, human clinical trials

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      In addition to granting marketing clearances for our products, the FDA and international regulatory authorities periodically inspect our facilities and operations. We must comply with the host of regulatory requirements that apply to medical devices marketed in the U.S. and internationally. These requirements include labeling regulations, manufacturing regulations, Quality System Regulation requirements, medical device reporting regulations that require a manufacturer to report to the FDA adverse events involving its products, and the FDA’s general prohibitions against promoting products for unapproved or off-label uses. The FDA periodically inspects device and drug manufacturing facilities in the U.S. or manufacturers of product to be marketed in the U.S. in order to assure compliance with applicable regulations.

      Cyclotrons. We believe that our cyclotrons are manufacturing equipment, rather than medical devices as defined under the Food, Drug and Cosmetic Act (i.e., they are not intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease, or intended to affect the structure or any function of the human body), and thus are not subject to regulation as medical devices. The FDA has not disputed our position regarding the regulatory status of our cyclotrons after numerous agency inspections of our facilities and operations over the past several years.

      Radiopharmaceuticals. Our PET radiopharmaceutical products currently are produced and sold through our PETNET radiopharmacies, each of which operates under an applicable state pharmacy license and compounds PET products in response to the prescription order of a licensed practitioner. The FDA traditionally has deferred regulation of the practice of medicine and pharmacy to state and local authorities. However, the Food and Drug Administration Modernization Act of 1997 (the “1997 Act”) provides a new framework for FDA regulation of PET products.

      FDA generally requires sponsors to submit a new drug application prior to marketing a drug to demonstrate that the drug is safe and effective for its intended uses. FDA will approve the new drug application only if the drug’s safety and effectiveness has been demonstrated by extensive, controlled clinical data, or by references to such data, and the sponsor has shown adequate manufacturing and controls. A sponsor may also submit an abbreviated new drug application, which does not require safety and effectiveness data, but generally requires a demonstration that the drug is “bioequivalent” to an already approved drug. Under the 1997 Act, FDA currently cannot require the submission of a new drug application or abbreviated new drug application for any compounded PET product that conforms to the PET compounding standards and the official monographs of the United States Pharmacopeia until two years after the agency adopts appropriate new drug approval procedures and current good manufacturing practice requirements for these products. The FDA believes that the 1997 Act directs the agency to establish approval procedures and current good manufacturing practice requirements for all PET products, without any exclusion for compounded PET products. Currently, any PET product that does not comply with United States Pharmacopeia PET compounding standards and official monographs is deemed by FDA to be adulterated and may not lawfully be sold.

      On March 10, 2000, FDA published a Federal Register notice announcing that the agency has concluded that certain commonly used PET products (e.g., FDG injection) are safe and effective for certain indications when produced under conditions specified in approved new drug applications and abbreviated new drug applications. In that notice, FDA invited producers of these products to voluntarily submit applications for marketing approval and set out the approval procedures and type of application

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      The language of the 1997 Act and FDA pronouncements within the March 10, 2000 notice strongly suggests that any FDA regulations pertaining to marketing approval for PET products would apply to the compounded PET products produced in our state-licensed PETNET radiopharmacies. Within two years after FDA regulation of PET products takes effect, our PET products would require FDA approval for a labeled (i.e., promoted) indication, including any indications related to the monitoring of disease.

      We believe, however, that the costs and time associated with obtaining FDA approval for FDG will not have a material impact on our business, financial condition, or results of operations; however, any failure to comply with applicable current good manufacturing practice requirements could delay FDA approval. We could incur significant costs and time to obtain FDA approval for any new PET product or for any new indication for an approved PET product. Such additional costs and expenditure of time in obtaining any required FDA approval could have a material adverse effect on our business, financial condition, and results of operations.

      On April 1, 2002, FDA published draft proposed current good manufacturing practice requirements for PET products. FDA states that it has determined that the production of a PET product would include all operations to the point of release of a finished dosage form (includes unit dose containers, multiple containers, and pharmacy bulk packages), and these activities would be subject to current good manufacturing practice.

      Until FDA adopts final current good manufacturing practice requirements for PET products, it is uncertain whether any such requirements will have a material impact on our radiopharmaceutical business. However, we may incur significant costs in establishing and maintaining procedures to comply with these requirements. When FDA finalizes its new drug approval and current good manufacturing practice requirements for the production and distribution of PET products, our failure to comply with agency requirements could result in FDA enforcement actions. These actions include, but are not limited to, recalls or product seizure, warning letters, fines, injunction, FDA refusal to grant approval of any required new drug applications or abbreviated new drug application, FDA withdrawal of approved applications, and criminal prosecution. Any such enforcement actions could have a material adverse effect on our business, financial condition, and results of operations.

      Finally, the 1997 Act established certain restrictions on pharmacy compounding that include, among other things, the prohibition of a pharmacy from advertising or promoting the compounding of any particular drug, class of drug, or type of drug. An April 2002 decision of the U.S. Supreme Court in the lawsuit Thompson v. Western States Medical Center held that the prohibition on promotion and advertising violates the free speech guarantees of the First Amendment. The U.S. Supreme Court was not asked to rule on the appellate court decision that the advertising restriction invalidates the entire pharmacy compounding section of the 1997 Act. Notwithstanding this advertising decision of the U.S. Supreme Court, FDA has clearly evidenced its desire to regulate the practice of pharmacy compounding, and in June 2002 reissued a Compliance Policy Guide that describes the FDA’s short-term policy on pharmacy compounding. The FDA is currently considering the long-term implications of the U.S. Supreme Court decision. Any such other regulatory limitations not related to advertising restrictions could adversely impact the operations of our PETNET radiopharmacies with respect to the compounding of PET drug products in general or of specific PET radiopharmaceuticals. We were not a party to the Thompson v. Western States Medical Center lawsuit.

      In order to market our products in European and other foreign countries, we must obtain required regulatory approvals and comply with extensive regulations governing product safety, quality and manufacturing processes. These regulations vary significantly from country to country and with respect to the nature of the particular medical device. The time required to obtain these foreign approvals to market

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      In order to market our products in the member countries of the European Union, we are required to comply with the Medical Devices Directive and obtain CE mark certification. CE mark certification is an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. Under the Medical Devices Directives, all medical devices must qualify for CE marking.

      All of our products sold internationally are subject to appropriate foreign regulatory approvals, like CE marking for the European Union. Our products are manufactured in ISO 9001 and ISO 13485 certified facilities.

      We also must obtain European marketing approval for our radiopharmaceuticals sold in Europe. We have obtained approval in the United Kingdom from the Medicines Control Agency (MCA) to produce and distribute FDG in England.

      Our scanners, cyclotrons, and PETNET radiopharmacies require the use of radioactive materials. While virtually all of this material has a short half-life, meaning it quickly breaks down into inert, or non-radioactive substances, using such materials presents the risk of accidental environmental contamination and physical injury. We are subject to federal, state and local regulations governing the storage, use, transportation and disposal of such materials and resulting waste products. Although we believe that our procedures for storing, handling, transporting and disposing of these hazardous materials comply with the standards prescribed by law and regulation, we cannot completely eliminate the risk of accidental contamination or injury from those hazardous materials. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could incur significant costs and the diversion of our management’s attention in order to comply with current or future environmental laws and regulations. We have not had significant material expenses associated with laws or regulations governing radioactive materials.

      In the U.S., as well as in foreign countries, government-funded or private insurance programs, commonly known as third-party payors, pay the cost of a significant portion of the patient’s medical expenses. A uniform policy of coverage and reimbursement does not exist among all these payors. Therefore, reimbursement for an item or service can be quite different from payor to payor. We believe that reimbursement is an important factor in the success of any medical device. Consequently, we seek to obtain third-party payor coverage and reimbursement for all of our products and services.

      In order to receive reimbursement from government funded insurance programs such as Medicare and Medicaid and to market our products in the U.S., we must first obtain FDA clearances and approvals. Reimbursement also depends on our ability to demonstrate the short-term and long-term clinical and cost-effectiveness of our products from the results we obtain from clinical experience and formal clinical trials. We present these results at major scientific and medical meetings and publish them in respected, peer-reviewed medical journals.

      All third-party reimbursement programs, whether government funded or insured commercially, whether inside the U.S. or outside, are developing increasingly sophisticated methods of controlling health care costs through prospective reimbursement and capitation programs, prior authorization of procedures, group purchasing, redesign of benefits, requiring second opinions prior to major surgery, careful review of bills, encouragement of healthier lifestyles and exploration of more cost-effective methods of delivering health care. In August 2000, CMS implemented the Hospital Outpatient Prospective Payment System in an effort to control costs to the Medicare program. The Hospital Outpatient Prospective Payment System

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      Under The Hospital Outpatient Prospective Payment System, PET services currently are treated as “new technology” services. It is not certain how much longer this status will apply. Pursuant to a recent adjustment to The Hospital Outpatient Prospective Payment System made by CMS, some of the radiopharmaceuticals we sell currently will no longer be eligible for pass-through payments in 2003. Instead, CMS indicated that these products will be incorporated into ambulatory payment classifications. It is expected that CMS will continue to refine The Hospital Outpatient Prospective Payment System as it collects more data on various reimbursable items and services. We cannot predict what impact the forthcoming changes in payments under The Hospital Outpatient Prospective Payment System for our products and services will have on the demand for such products from hospitals and provider-based entities.

      In addition, non-governmental third-party payors, such as commercial health maintenance organizations, preferred provider organizations and other insurers, may similarly impose varying requirements and limitations on reimbursement for our products or for services utilizing our products, thereby affecting the demand for our products from health care providers.

      Currently, we are working with the Academy of Molecular Imaging to form a European organization which, among other things, will work to increase the level of reimbursement for PET applications in the European market.

      On April 16, 2002, the Executive Committee of the Medicare Coverage Advisory Committee, which provides advice and recommendations to CMS about clinical issues, held a hearing regarding the scientific justification for the use of PET applications for the diagnosis and management of Alzheimer’s disease. At this meeting, the Executive Committee voted to ratify earlier conclusions of the Medicare Coverage Advisory Committee’s Diagnostic Imaging Panel that currently there is not adequate evidence of a clinical benefit of PET in evaluating patients with possible Alzheimer’s disease and, therefore, CMS should not at this time provide Medicare coverage for the use of PET in the diagnosis and management of Alzheimer’s disease. The negative recommendation came despite evidence from scientists representing the Academy of Molecular Imaging that PET is the only current technology available that can definitively diagnose Alzheimer’s disease. At this time, CMS has not indicated whether it will follow the recommendations of the Medicare Coverage Advisory Committee when making its Medicare reimbursement coverage decision. However, if CMS does follow the recommendations of the Medicare Coverage Advisory Committee, we would expect the decision to be re-evaluated in the future if and when additional evidence becomes available regarding PET’s clinical benefits in evaluating patients with possible Alzheimer’s disease.

      The federal health care program’s anti-kickback law, the Anti-Kickback Law, prohibits persons from knowingly and willfully offering, paying, soliciting, or receiving remuneration, directly or indirectly, in exchange for or to induce either: (i) the referral of an individual, or (ii) the purchasing, leasing, ordering, or arranging for, or recommending the purchase, lease or order of, any service or item for which payment may be made by Medicare, Medicaid or certain other federal health care programs. The definition of

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      The Anti-Kickback Law is broad, and it prohibits many arrangements and practices that are lawful in businesses outside of the health care industry. Recognizing that the Anti-Kickback Law is broad and may technically prohibit many innocuous or beneficial arrangements within the health care industry, the U.S. Department of Health and Human Services(HHS) has issued a series of regulations, known as the “safe harbors.” These regulations set forth certain safe harbors which, if all applicable requirements are met, will assure health care providers and other parties that they will not be prosecuted under the Anti-Kickback Law. Although full compliance with all applicable safe harbors ensures against prosecution under the Anti-Kickback Law, the failure of a transaction or arrangement to fit within one or more safe harbors does not necessarily mean that the transaction or arrangement is illegal or that prosecution under the Anti-Kickback Law will be pursued. However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the Office of the Inspector General of the HHS, referred to as the OIG. To provide specific guidance on the application of the Anti-Kickback Law, Congress required the OIG to implement an advisory opinion process. In an advisory opinion, the OIG may determine that it will not sanction the advisory opinion’s requestor even if the arrangement or practice in question technically violates the Anti-Kickback Law. Although these advisory opinions are binding on the OIG and the parties requesting the opinions, no third-party may legally rely on them.

      Many states have adopted laws similar to the Anti-Kickback Law. Some of these state prohibitions apply to referrals for health care items and services reimbursed by any source, not only the Medicare and Medicaid Programs. Some of these state prohibitions may be more restrictive than the Anti-Kickback Law in material respects, and the federal safe harbors may not apply.

      These laws constrain the sales, marketing and other promotional activities of manufacturers of medical devices, such as us, by limiting the kinds of financial arrangements (including sales programs) we may have with hospitals, physicians, imaging centers, and other potential purchasers of medical devices. We have in place formal policies related to compliant marketing practices. These laws are also implicated by a manufacturer’s compensation or ownership arrangements with customers (or physicians in a position to recommend the purchase of a manufacturer’s products). We have various types of compensation arrangements with customers and physicians, including consulting agreements, research and development agreements, and lease agreements. Furthermore, we have a number of joint venture arrangements with customers to establish and operate PETNET radiopharmacies. We believe that these various arrangements have been structured to comply with federal and state anti-kickback laws. For example, we believe the various compensation arrangements, which we have with customers, provide for fair market value compensation for services and/or space furnished to us. Additionally, we believe that the PETNET joint venture arrangements require at-risk investments and provide for returns on investment, which are proportional to the level of investment. Given the breadth of the federal and state anti-kickback laws, however, there can be no assurance that federal or state regulatory authorities will determine that all of our arrangements comply with these laws. We have attempted to structure our business arrangements to comply with the Anti-Kickback Law and similar state laws, but there can be no assurances to this effect.

      Other federal and state laws prohibit individuals or entities from presenting, or causing to be presented, claims for payment to third-party payors (including Medicare and Medicaid) that are false or fraudulent or are for items or services not provided as claimed. Violations of these laws can result in substantial criminal and civil penalties. Although we do not submit claims in our own behalf to third-party payors, we may provide some billing and reimbursement advice to purchasers of our products. Since we cannot assure that the government will regard any billing errors that may be made by a customer relying on our advice as inadvertent, these laws are potentially applicable to us.

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      Both federal and state government agencies are continuing heightened and coordinated civil and criminal enforcement efforts. The federal government has increased funding to fight health care fraud, and it is coordinating its enforcement efforts among various agencies, such as the United States Department of Justice, the OIG, and state Medicaid fraud control units. We believe that the health care industry will continue to be subject to increasing government scrutiny and investigations.

      In 1996 Congress passed the Health Insurance Portability and Accountability Act (HIPAA). Among other things, HIPAA established several requirements regarding the privacy, security and transmission of health information. HHS has issued several sets of regulations in accordance with its authority under HIPAA. In general, these regulations apply directly to health care providers, health plans, and health care clearinghouses, as well as indirectly, in certain instances, to those who provide services on behalf of these entities which involve the receipt or disclosure of health information. Our health plan will be subject to the HIPAA regulations. Some of our operations may also be subject to these regulations.

      Pursuant to HIPAA, HHS issued final privacy regulations establishing comprehensive federal standards relating to the use and disclosure of protected health information. These regulations, among other things, establish limits on the use and disclosure of protected health information, provide for patients’ rights to access, request amendments, and receive an accounting of the uses and disclosures of protected health information, and require certain safeguards to protect identifiable health information. The federal privacy regulations do not supersede state privacy laws that are more stringent. Thus, to the extent we are subject to the privacy regulations, we must determine which state privacy laws are more stringent than the federal laws and comply with those state laws in addition to the federal privacy regulations. The compliance date for the federal privacy regulations is April 14, 2003. Prior to the compliance date, it is expected that HHS will release several guidance documents addressing questions or concerns raised by the privacy regulations. On July 6, 2001, HHS issued its first guidance document relating to these regulations. On August 14, 2002, HHS issued a final rule modifying certain provisions of the HIPAA privacy regulations. HHS may propose additional modifications in the future.

      Like the privacy regulations, the regulations providing electronic transaction standards also are finalized. These regulations establish uniform standards relating to data reporting, formatting, and coding that covered entities must use in conducting certain health care transactions. The electronic transaction standards presently apply to eight different transactions, including transactions relating to health care claims and health care payment and remittance advice. The compliance date for these regulations was October 16, 2002. However, the compliance date for these regulations could be extended for one year by filing a compliance plan with HHS by October 15, 2002. We filed a compliance plan with HHS for purposes of the transactions conducted by our health plan. Outside of our health plan, we do not believe we are subject to the electronic transaction standards since we do not otherwise conduct any of the covered transactions.

      The security regulations promulgated pursuant to HIPAA have not been finalized. The purpose of the proposed security regulations is to establish a minimum standard for the protection of individual health information that is stored or transmitted electronically. The regulations provide administrative procedures, physical safeguards, and technical mechanisms that may be implemented to satisfy the regulations.

      Violations of the privacy regulations are punishable by civil and criminal penalties. State privacy laws may impose similar sanctions on us. Violations of the electronic transactions standards are punishable by civil penalties.

      The HIPAA regulations could result in significant financial obligations for us and will pose increased regulatory risk. At this time, we are not able to determine the full consequences of the HIPAA regulations for our business or the total cost of complying with these regulations. However, the HIPAA regulations could have a significant impact on us operationally and financially.

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Employees

      As of September 30, 2002, we employed directly and through our subsidiaries 699 people. Of these 699 people, 236 work in our PET scanner manufacturing business, 193 work in our radiopharmaceutical business, 44 work in our detector materials business, 154 work in our services business for scanners, cyclotrons, and other products, and the remaining 72 work in various administrative functions supporting all of these businesses. None of our employees is subject to a collective bargaining agreement. We consider our relationships with our employees to be good.

Item 2.     Properties

      We currently own 115,000 square feet of office, research and development, manufacturing and warehouse space at 810 Innovation Drive in Knoxville, Tennessee, and 50,000 square feet of production space at 3100 Stock Creek Boulevard in Rockford, Tennessee. We are in the process of expanding our facility at 810 Innovation Drive by more than 76,000 square feet. We expect this expansion to be completed by January 2003. We have entered into a lease for approximately 16,000 square feet of office space located at 800 Innovation Drive in Knoxville, Tennessee; a sub-lease for 5,600 square feet of office space located at 800 Innovation Drive in Knoxville, Tennessee; a lease for approximately 5,000 square feet of office space at 835 Innovation Drive in Knoxville, Tennessee and a lease for 10,000 square feet of warehouse space at 516 Cardin Jennings Lane in Knoxville, Tennessee. Except for the space located at 3100 Stock Creek Boulevard in Rockford, Tennessee, which is used primarily by our Detector Materials segment, each of the foregoing facilities is used in part by each of our financial reporting segments.

      CTI PET Systems currently leases office, research and development, manufacturing and warehouse space at 810 Innovation Drive in Knoxville, Tennessee from CTI. The board of directors of CTI PET Systems has authorized CTI PET Systems to enter into a new lease agreement with CTI for a period of ten years through December 31, 2012. CTI PET Systems entered into a lease for approximately 21,000 square feet of office and warehouse space located at 203 Dunavant Drive, in Rockford, Tennessee. CTI PET Systems currently subleases 1,501 square feet of space in a medical facility in Knoxville, Tennessee, which is used in research and development activities.

      We currently lease space for 25 PETNET radiopharmacies throughout the U.S., including metropolitan areas such as New York, Chicago, Tampa, San Francisco, Los Angeles, Phoenix, Dallas, Detroit and Nashville. Two of these leased properties are locations for future radiopharmacies. We operate 12 of our radiopharmacies in facilities that are owned by other parties and for which our use of the facilities is governed by our commercial agreements with those parties rather than separate facility leases. In addition, we have a PETNET radiopharmacy located in Mt. Vernon, United Kingdom.

      We also have an office in Germany that houses a sales manager for international sales and several engineers to provide service and support for products sold in Europe. This facility in Germany is used by our CTI Services segment.

Item 3.     Legal Proceedings

      In May 2002, Cox Nuclear Pharmacy, Inc. & Accuscan LLC filed an action against CTI, PETNET Pharmaceuticals, Inc. and an employee of PETNET, in the United States District Court for the Southern District of Alabama, Southern Division, civil action no. 02-cv-0321-CG-C. The plaintiffs have set forth eight causes of action against the defendants, including a breach of contract claim related to the sale of a cyclotron and various tort claims alleging violation of a covenant not to compete in the Mobile, Alabama market. The plaintiffs are seeking $20 million in compensatory damages on the breach of contract claims and $50 million in aggregate compensatory and punitive damages on the tort claims. Because our investigation with respect to the allegations remains at a preliminary stage, an estimate of the possible loss or range of loss, if any, cannot be made. Nevertheless, we believe that the claims are without merit and intend to vigorously defend this suit.

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      On November 21, 2002, General Electric Company filed an action against us and a former General Electric employee now employed by us in the District Court of Johnson County, Kansas, civil case no. 02-CV-07947. The complaint charges us and our employee with alleged misappropriation of trade secrets and unfair competition, and the employee with breach of contract and breach of fiduciary duty. The complaint seeks injunctive relief and an undisclosed amount of damages. On November 21, 2002, General Electric, without notice to us or our employee, obtained a temporary restraining order enjoining the employee from using General Electric’s confidential information and trade secrets, and enjoining us from disclosing or using any confidential information or trade secrets gained by the employee during his employment at General Electric. General Electric obtained a second temporary restraining order on December 5, 2002, again without notice to us or our employee, ordering us and our employee to preserve all information in paper or electronic form that was provided to us by such employee or created or generated by us or any of our employees based upon information provided by such former General Electric employee. We have initiated an investigation into the facts alleged by General Electric and have taken steps to comply with the Court’s orders. We intend to vigorously defend this cause of action.

      On September 19, 2002, General Electric filed a complaint against Thomas J. Hook and Joseph Sardano, who were former employees of General Electric and are now employed by us, in the United States District Court, Eastern District of Wisconsin, civil case no. 02-C-929. The complaint alleges threatened or actual misappropriation of trade secrets, breach of contract and unfair competition. We have not been named as a defendant in that action. The defendants have answered the complaint, have denied liability and intend to vigorously defend this cause of action.

      We are also involved in various other lawsuits and claims arising in the normal course of business. Although the outcomes of these other lawsuits and claims are uncertain, we do not believe any of them will have a material adverse effect on our business, financial condition or results of operations.

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

      No matter was submitted to a vote of security holders during the fiscal quarter ended September 30, 2002.

PART II

Item 5.     Market for Registrant’s Common Equity and Related Stockholder Matters

Price Range of Common Stock

      The Company’s Common Stock has been traded on the Nasdaq National Market (Nasdaq symbol: CTMI) since June 21, 2002. The following table sets forth the high and low sales prices as reported on the Nasdaq National Market for the quarters ended June 30, 2002 and September 30, 2002.

Holders

      The number of record holders of the Company’s Common Stock at December 2, 2002 was 197, excluding beneficial owners of shares registered in nominee or street name.

Dividend Policy

      The Company has not paid any cash dividends on its common stock since its inception, and does not intend to pay any such dividends in the foreseeable future. Pursuant to the terms of our existing credit facility, we are restricted from paying dividends. See Item 7 of this annual report under the sub-heading “Liquidity and Capital Resources.”

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Securities Authorized for Issuance Under Equity Compensation Plans

      The following table summarizes our equity compensation plans as of September 30, 2002:

(1)

Includes warrants to acquire 76,000 shares issued in connection with the execution of a consulting agreement and 406,664 options issued outside of our 1998 Amended and Restated Incentive Stock Option Plan to certain non-employee advisors and consultants. See “Stock Options, Warrants and Restricted Stock” in note 9 of the notes to our consolidated financial statements appearing elsewhere in this annual report

Sales of Unregistered Securities

      During the quarter ended September 30, 2002, we had no sales of unregistered securities. Sales of unregistered securities made by us in the quarter ended June 30, 2002 have been disclosed in our 10-Q filed on August 14, 2002. During the quarters ended December 31, 2002 and March 31, 2002, we had the following sales of unregistered securities:

      In March 2002, in reliance upon Section 4(2) of the Securities Act, we issued 21,440 shares of our common stock to one of our employees at $4.69 per share in lieu of a bonus for fiscal year 2002.

      In March 2002, in reliance upon Section 4(2) of the Securities Act, one of our shareholders exercised, on a cashless basis, warrants to purchase 2,447,181 shares of our outstanding common stock resulting in a net issuance of 2,446,563 shares of our common stock at an aggregate exercise price valued at $3,431.76.

Use of Offering Proceeds

      The Registration Statement on Form S-1 (File No. 333-85714) for our initial public offering was declared effective on June 20, 2002, and on June 26, 2002 we closed the initial public offering of our common stock. The net offering proceeds received by us, after deducting underwriting discounts and commissions and estimated offering expenses of approximately $16,042,600, was approximately $171,386,894. As of September 30, 2002, $10,214,521 of the net offering proceeds had been used to redeem all of our Series A Redeemable Preferred Stock, including all accrued dividends, $342,644 of the net offering proceeds had been used to redeem 1,191,165 shares of our common stock, and approximately $62,000,000 of the net offering proceeds had been used to decrease our outstanding balance under our credit facility and approximately $14,503,000 had been used to extinguish capital lease obligations. The balance of the net offering proceeds have been invested in highly liquid instruments, such as commercial paper and U.S. government obligations, with an average maturity of twelve months or less.

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      You should read the following selected consolidated financial data in conjunction with “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8: Financial Statements and Supplementary Data”. We have derived the selected financial data set forth below from our audited financial statements and related notes.

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      The following discussion and analysis contains forward-looking statements about our plans and expectations of what may happen in the future. Forward-looking statements are based on a number of assumptions and estimates that are inherently subject to significant risks and uncertainties, and our results could differ materially from the results anticipated by our forward-looking statements as a result of many known or unknown factors, including, but not limited to, those factors discussed below in this Item under the sub-heading “Factors Affecting Operations and Future Results.” See also the “Cautionary Notice Regarding Forward-Looking Statements” set forth at the beginning of this report.

      You should read the following discussion and analysis in conjunction with “Item 6 — Selected Consolidated Financial Data” and “Item 8 — Consolidated Financial Statements and Supplementary Data” appearing elsewhere in this report.

Overview

      We are a leading manufacturer of positron emission tomography imaging equipment and related products used in the detection and treatment of cancer, cardiac disease and neurological disorders. Positron emission tomography, or PET, is a medical imaging technology that offers the distinct advantage of imaging at a molecular level thereby allowing physicians to diagnose and treat a broad range of diseases earlier and more accurately than other medical imaging technologies. We also provide a comprehensive array of services that facilitate entry by health care providers into the business of PET imaging. Our line of PET products and services includes scanners, cyclotrons, detector materials, production and distribution of radiopharmaceuticals, and distribution and related support services.

      Historically, the majority of our consolidated revenues, gross margin and net income have been attributable to our CTI PET Systems segment. Our strategy includes plans for growing our other segments over time with a goal of having greater than 50% of our gross revenues and net income being derived from such other segments by 2006, the expected year that Siemens’ could first close on the exercise of its option to purchase CTI PET Systems. This strategy contemplates the following initiatives: (1) expansion of our PETNET radiopharmaceutical distribution network to meet market needs; (2) direct distribution of PET scanners by CTI; (3) development of new proprietary radiopharmaceuticals; (4) growing our service contract business; and (5) adding additional products and services.

      We operate in four segments for financial reporting purposes: CTI PET Systems; PETNET; Detector Materials’, and CTI Services. In addition, we have other business operations that are not classified as separate segments for financial reporting purposes, including general corporate activities.

      Our CTI PET Systems segment includes the development, production and sale of PET and PET/CT scanners. We conduct this business through our subsidiary, CTI PET Systems, Inc., which was formed in 1987 as a joint venture with Siemens Medical Solutions USA, Inc., a wholly owned subsidiary of Siemens, AG. We own 50.1% of CTI PET Systems and Siemens owns the remaining 49.9%.

      From 1987 until April 2001, the products of CTI PET Systems were distributed exclusively by Siemens. Under this distribution agreement, CTI PET Systems received and recognized revenue in an amount equal to the price to the customer and we paid Siemens a fee to cover its selling, marketing, and distribution costs. These fees were reported as costs of revenues and selling expenses in our consolidated statements of operations. Under this agreement, we set the price to the end customer, had ultimate liability to the end customer for product performance, and retained credit risk associated with sales to end customers.

      In April 2001 we implemented a multiple distributor strategy for CTI PET Systems by commencing direct distribution and by pursuing additional third-party distributor agreements. In November 2001 we

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      The scanners manufactured by CTI PET Systems have historically ranged in customer price from $800,000 to $2.5 million and offer customers a broad range of throughput times, resolution and image quality.

      Our PETNET segment consists of our business of developing, producing and distributing radiopharmaceuticals and providing certain PET related services such as reimbursement education, radiation safety consulting, licensure assistance and marketing assistance. We conduct this business through our subsidiary, PETNET Pharmaceuticals, Inc.

      We currently operate 35 PETNET radiopharmacies in the U.S. and 1 radiopharmacy in the United Kingdom. Twelve of these radiopharmacies operate cyclotrons owned by other parties, or hosts, pursuant to contracts. These host contracts vary but typically require us to provide radiopharmaceuticals to the host at below market prices while also allowing us to use the host’s facility to manufacture and distribute radiopharmaceuticals commercially to third parties. In addition, we typically compensate the host for the use of the cyclotron. The 36 radiopharmacies PETNET operates also include four radiopharmacies we do not consolidate. While, PETNET owns 50.1% of these radiopharmacies, we do not exert significant influence to control the activities of these four radiopharmaceutical production and distribution facilities.

      Our CTI Detector Materials segment includes our business of developing, manufacturing and selling detector materials for use in PET scanners. We conduct this business through a wholly owned subsidiary named Advanced Crystal Technology, Inc. and an unincorporated division of CTI called CTI Detector Materials. We acquired Advanced Crystal Technology, Inc. in July 1999.

      Advanced Crystal Technology, Inc. manufactures bismuth germanate, or BGO, the primary detector material used in the current generation of PET scanners. Our CTI Detector Materials division has exclusive rights to the development and manufacturing of a next generation detector material called lutetium oxyorthosilicate, or LSO. We acquired these exclusive rights from Schlumberger Technology Corporation in February 1995. The rights terminate upon the expiration of Schlumberger’s patents for LSO, which are expected to expire in October 2008. We have invested significant capital in CTI Detector Materials in order to meet an expected increase in demand for detector materials as the PET market continues to grow.

      Our CTI Services segment includes:

	•	CTI’s division that distributes and installs PET scanners manufactured by CTI PET Systems;
	•	CTI’s division that manufactures, sells and installs cyclotrons;
	•	CTI’s subsidiary that manufactures and sells calibration sources;
	•	CTI’s domestic product service division;
	•	CTI’s German subsidiary that distributes and services our products in Europe; and
	•	CTI’s 50% ownership interest in a radiopharmacy joint venture in Turkey, which we do not consolidate.

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      Our revenue is derived primarily from sales of PET products and services. Revenue for scanners, detector materials, radiopharmaceuticals, calibration sources and spare parts is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable, and collectibility is probable. Delivery is considered to have occurred upon either shipment or arrival at destination depending on shipping terms. Amounts attributable to the installation of scanners are deferred and recognized upon completion of installation. Most of the revenue for detector materials is from sales to CTI PET Systems and, therefore, is eliminated in consolidation for financial reporting purposes. Revenue for cyclotron systems is recognized upon successful installation and customer acceptance. Installation is deemed essential to the functionality of the machines and we alone provide this service for our cyclotrons. Revenue for service contracts is recognized ratably over the period the service is provided.

      Our scanners, cyclotrons, detector materials, calibration sources and spare parts are manufactured at our facilities in Knoxville and Rockford, Tennessee. Our radiopharmaceuticals are manufactured at 36 PETNET radiopharmacies. We employ a network of PET field service engineers to service our installed base of scanners and cyclotrons.

      Cost of revenues consists primarily of:

	•	purchase cost of materials;
	•	expenses related to internal operations of the manufacturing and service organizations;
	•	expenses related to technical support and maintenance;
	•	expenses related to distribution, shipping, installation, acceptance, and warranty of our products;
	•	royalties payable under technology licenses; and
	•	fixed asset depreciation, primarily for our detector materials and radiopharmacies.

      Selling, General and Administrative. Selling, general and administrative expenses consist primarily of:

	•	salaries, commissions and related expenses for personnel engaged in sales, general and administrative activities;
	•	costs associated with advertising, trade shows, promotional and other marketing activities; and
	•	legal and accounting fees for professional services.

      Research and Development. Significant investment in research and development has been made, and we believe will continue to be required, to develop new products and enhance existing products to allow us to further penetrate the PET market. These expenses consist primarily of:

	•	salaries and related personnel expenses;
	•	expenditures for prototype materials and supplies;
	•	overhead allocated to product development;
	•	legal costs associated with filing of patents and regulatory matters; and
	•	research grants and consulting fees to various third parties.

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Results of Operations

      The following table shows revenues, cost of revenues, selling, general and administrative expenses, research and development expenses, stock-based compensation and income (loss) from operations for all segments, expressed in millions of dollars.

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      The following table shows revenues and income (loss) from operations for all segments, expressed as a percentage of consolidated revenues and consolidated income (loss) from operations, respectively.

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      The following table shows revenues, cost of revenues, selling, general and administrative expenses, research and development expenses, stock-based compensation expenses and income from operations for all segments, expressed as a percentage of segment revenues.