CTI MOLECULAR IMAGING INC - 10-Q Quarterly Report

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

(Mark One)


x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended March 31, 2003


o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to

Commission File Number: 000-49867

CTI MOLECULAR IMAGING, INC.

(exact name of registrant as specified in its charter)


Delaware (State of Incorporation)		62-1377363 (I.R.S. Employer Identification No.)


810 Innovation Drive, Knoxville, Tennessee 37932
(Address of Principal Executive Offices)	(Zip Code)

(865) 218-2000
(Registrant’s Telephone Number, Including Area Code)

Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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 x No o

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

APPLICABLE ONLY TO CORPORATE ISSUERS

As of May 1, 2003, the registrant had outstanding 44,781,006 shares of common stock, par value $0.01.

TABLE OF CONTENTS


		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
	ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
	ITEM 4. Controls and Procedures
Part II: Other Information
	ITEM 1. Legal Proceedings
	ITEM 2. Changes in Securities and Use of Proceeds
	ITEM 3. Defaults Upon Senior Securities
	ITEM 4. Submission of Matters to a Vote of Security Holders
	ITEM 5. Other Information
	ITEM 6. Exhibits and Reports on Form 8-K
SIGNATURE
CERTIFICATIONS
EXHIBIT INDEX
EX-99.1 SECTION 906 CERTIFICATION OF THE CEO
EX-99.2 SECTION 906 CERTIFICATION OF THE CFO

CTI Molecular Imaging, Inc.
Quarterly Report on Form 10-Q

Table of Contents


		Page

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS			3
	PART I
	Financial Information
Item 1.	Condensed Consolidated Financial Statements:
	Condensed Consolidated Balance Sheets at March 31, 2003 and September 30, 2002		4
	Condensed Consolidated Statements of Operations for the Three Months and Six Months Ended March 31, 2003 and 2002		5
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2003 and 2002		6
	Notes to Condensed Consolidated Financial Statements		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		49
Item 4.	Controls and Procedures		50
	PART II
	Other Information
Item 1.	Legal Proceedings		51
Item 2.	Changes in Securities and Use of Proceeds		51
Item 3.	Defaults Upon Senior Securities		52
Item 4.	Submission of Matters to a Vote of Security Holders		52
Item 5.	Other Information		52
Item 6.	Exhibits and Reports on Form 8-K		52
SIGNATURE			53
CERTIFICATIONS			54
EXHIBIT INDEX			56

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 March 31, 2003;

• 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 CPS 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;

• our ability to develop new proprietary radiopharmaceuticals;

• 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 our 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 I, Item 2 of this report under the sub-heading “Factors Affecting Operations and Future Results.”

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 currently 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.

CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS


			March 31,			September 30,
(In thousands, except share and per share data)			2003			2002

			(unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	75,949		$	84,553
	Marketable securities			3,553			6,704
	Accounts receivable — trade, less allowance for doubtful accounts of $2,120 at March 31, 2003 (unaudited) and $1,576 at September 30, 2002, respectively			43,390			33,817
	Accounts receivable — related party, less allowance for doubtful accounts of $242 at at March 31, 2003 (unaudited) and September 30, 2002			31,193			39,918
	Inventories			83,584			69,295
	Income tax receivable			1,054			—
	Deferred tax asset			15,032			9,827
	Prepaid expenses and other current assets			8,081			6,112

		Total current assets		261,836			250,226

Property and equipment, net				95,577			77,667
Deferred tax asset				—			187
Goodwill				12,545			12,385
Other assets				10,944			11,244

		Total assets	$	380,902		$	351,709

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Cash management clearing		$	2,994		$	2,121
	Accounts payable			32,392			26,591
	Current maturities of long-term debt and capital lease obligations			4,462			4,008
	Accrued payroll and benefits			11,300			12,914
	Customer advances — trade			12,193			16,487
	Customer advances — related party			1,201			1,214
	Accrued warranty expense			3,142			3,740
	Income taxes payable			—			4,552
	Other accrued expenses			1,922			2,339

		Total current liabilities		69,606			73,966

Deferred revenues				1,489			1,420
Deferred tax liability				236			—
Long-term debt and capital lease obligations, less current maturities				28,820			26,730

		Total liabilities		100,151			102,116

Commitments and contingencies (Note 5)
Minority interest				37,865			30,104
Shareholders’ equity:
	Common stock, $.01 par value; 500,000,000 shares authorized, 45,956,912 shares issued and 44,124,947 shares outstanding at March 31, 2003 (unaudited); 44,048,117 shares issued and 42,216,152 shares outstanding at September 30, 2002			460			440
	Additional paid-in capital			239,603			226,910
	Retained earnings			8,548			644
	Unearned compensation			(5,437	)		(7,526	)
	Other comprehensive income — currency translation adjustment			675			(16	)
	Treasury stock, at cost, 1,831,965 shares			(963	)		(963	)

		Total shareholders’ equity		242,886			219,489

		Total liabilities and shareholders’ equity	$	380,902		$	351,709

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

CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


				Three Months Ended						Six Months Ended
				March 31,						March 31,

(In thousands, except share and per share data)				2003			2002			2003			2002

				(unaudited)						(unaudited)
Revenues ⁽¹⁾				$	81,964		$	55,258		$	142,523		$	102,815
Cost of revenues ^{(2) (3)}					49,384			32,542			82,030			60,962

			Gross margin		32,580			22,716			60,493			41,853

Operating expenses:
	Selling, general and administrative expenses ⁽³⁾				12,429			8,458			24,633			15,682
	Research and development expenses ⁽³⁾				7,435			4,869			14,064			9,453
	Stock-based compensation expense				325			8,134			881			8,236

		Total operating expenses			20,189			21,461			39,578			33,371

Income from operations					12,391			1,255			20,915			8,482
Warrant liability mark to market expense					—			6,761			—			8,902
Interest expense, net					199			1,134			275			2,296
Other (income)					(238	)		(220	)		(679	)		(394	)

Income (loss) before income taxes and minority interest					12,430			(6,420	)		21,319			(2,322	)

Provision (benefit) for income taxes:
	Current				4,180			3,020			7,680			5,158
	Deferred				414			(845	)		406			(556	)

					4,594			2,175			8,086			4,602

Income (loss) before minority interest					7,836			(8,595	)		13,233			(6,924	)
Amount applicable to minority interest, net of taxes					3,316			3,249			5,329			4,915

Net income (loss)					4,520			(11,844	)		7,904			(11,839	)

Accretion of preferred stocks					—			490			—			704
Dividends on preferred stocks					—			495			—			848

Net income (loss) attributable to common shareholders				$	4,520		$	(12,829	)	$	7,904		$	(13,391	)

Earnings (loss) per share (Note 2):
	Basic			$	0.11		$	(0.46	)	$	0.19		$	(0.48	)
	Diluted			$	0.10		$	(0.46	)	$	0.17		$	(0.48	)
Weighted average shares:
	Basic				42,929,659			28,160,987			42,467,888			28,121,253
	Diluted				46,582,627			28,160,987			46,610,690			28,121,253
⁽¹⁾Includes revenues through related parties				$	37,131		$	27,342		$	62,385		$	54,537
⁽²⁾Includes cost of revenues through related parties				$	23,911		$	13,654		$	38,585		$	31,051
⁽³⁾Excludes stock-based compensation expense as follows:
			Cost of revenues	$	46		$	18		$	112		$	18
			Selling, general and administrative expenses		195			8,032			584			8,134
			Research and development expenses		84			84			185			84

				$	325		$	8,134		$	881		$	8,236

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

CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


					Six Months Ended
					March 31,

					2003			2002

(In thousands, except share and per share data)					(unaudited)
Cash flows provided by operating activities:
	Net income (loss)				$	7,904		$	(11,839	)
	Adjustments to reconcile net income to net cash provided by operating activities:
		Minority interest in income of subsidiaries				5,329			4,915
		Depreciation and amortization				5,205			3,062
		Accretion of discount on marketable securities				(52	)		—
		Deferred tax (benefit) provision				406			(556	)
		Provision for bad debts				652			1,410
		Equity in loss (income) of equity investees				5			(210	)
		Stock-based compensation expense				881			8,236
		Provision to mark to market warrant liability				—			8,902
		(Gain) loss on disposal of machinery and equipment				(168	)		155
		Changes in operating assets and liabilities, net of effect of consolidation of joint venture
			Accounts receivable			(432	)		4,319
			Inventories			(12,289	)		(17,700	)
			Other receivables			102			330
			Prepaid expenses and other current assets			(441	)		(198	)
			Accounts payable			5,543			4,071
			Accrued payroll and benefits			(1,662	)		(1,412	)
			Customer advances			(4,307	)		2,000
			Accrued warranty expense			(598	)		137
			Income taxes receivable (payable)			(4,518	)		(2,399	)
			Other accrued expenses			(199	)		(661	)

				Net cash provided by operating activities		1,361			2,562

Cash flows used in investing activities:
Additions to property and equipment						(19,115	)		(9,345	)
Purchase of marketable securities						(7,897	)		—
Proceeds from sale of marketable securities						11,100			—
Cash acquried from consolidation of joint venture						64			—
Additions to other assets						(246	)		(357	)

				Net cash used in investing activities		(16,094	)		(9,702	)

Cash flows provided by financing activities:
Increase (decrease) in cash management clearing						864			(651	)
Proceeds from exercise of stock options						4,591			49
Retirements of common stock						—			(250	)
Proceeds from issuance of common stock, net of offering costs						1,275			9
Issuance of long-term debt						602			2,918
Payment of dividends on preferred stock						—			(449	)
Unused proceeds from bond issue						—			(76	)
Principal payments on long-term debt and capital lease obligations						(1,894	)		(3,092	)
Draws on line of credit						39,751			78,230
Payments under line of credit						(39,751	)		(69,814	)

				Net cash provided by financing activities		5,438			6,874

Effect of foreign currency exchange rates on cash and cash equivalents						691			(117	)

Net decrease in cash and cash equivalents						(8,604	)		(383	)
Cash and cash equivalents, beginning of year						84,553			1,827

Cash and cash equivalents, end of year					$	75,949		$	1,444

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

CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)

1. Organization and Presentation

The unaudited condensed consolidated financial statements include the accounts of CTI Molecular Imaging, Inc. (CTI) and all of its subsidiaries (the “Company”), namely CTI Services, Inc. (Services), Advanced Crystal Technology, LLC (ACT), CTI GmbH (GmbH), PETNET Pharmaceuticals, Inc. and all of its subsidiaries (PETNET), and CTI PET Systems, Inc., doing business as CPS Innovations (CPS). All of the subsidiaries are wholly owned except for CPS in which CTI owns 50.1%. The balance of CPS is owned by Siemens Medical Solutions USA, Inc. (Siemens).

The Company’s products and services can be broadly classified into four principal categories: Positron Emission Tomography (PET) scanners, radiopharmaceuticals, detector materials, and other PET products and services. CPS manages the development and production and sale of the ECAT® line of PET scanners. PETNET develops, produces and distributes radiopharmaceuticals. ACT and CTI’s unincorporated division, Detector Materials, develops and manufactures detector materials used in PET scanners. CTI Services includes the direct sale and service by CTI of the ECAT® line of PET scanners, cyclotron systems and other PET related products.

2. Summary of Significant Accounting Policies

Interim Financial Statements — The unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Form 10-K previously filed with the SEC on December 19, 2002. Information in the accompanying unaudited condensed consolidated financial statements and notes to the financial statements for the three month and six month periods ended March 31, 2003 and 2002, is unaudited. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of financial position, results of operations and cash flows for the periods presented have been included. Operating results for the three month and six month periods ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending September 30, 2003 or any future period.

Principles of Consolidation — All significant intercompany balances and transactions have been eliminated. The Company periodically enters into arrangements in which it holds a majority of the equity ownership. In some instances, the Company also has influence over a majority of the board of directors or managers. The Company determines accounting for these investments under Statement of Financial Accounting Standard (SFAS) No. 94 and Accounting Principles Board (APB) Opinion No. 18 and, where appropriate, evaluates its and the minority shareholders’ participating rights in accordance with Emerging Issues Task Force (EITF) Issue 96-16 to determine whether consolidation or equity method accounting is appropriate in each case.

CTI owns a majority interest in CPS. Under the terms of the CPS operating agreement, CTI has influence over a majority of the board of directors. Decisions deemed participating rights, including approval of operating budgets and management compensation, are determined by a majority vote of the board of directors. The board of directors of CPS consists of two directors selected by CTI, two directors selected by Siemens, and a fifth director selected by Siemens from a list of persons selected by CTI. Neither Siemens nor any member of the board of directors of CPS who was selected or nominated by Siemens has any substantive participating or veto rights with regard to significant operating, budget, capital and other decisions. CPS is consolidated in the Company’s financial statements.

PETNET owns 90.0% and 51.0% interests in radiopharmacies in Denver and Houston, respectively. Under the terms of the Denver and Houston radiopharmacy operating agreements, PETNET has control over all significant operating decisions and these radiopharmacies are consolidated in our financial statements. PETNET accounted for the Houston joint venture under the equity method in the 2002 financial statements in accordance with EITF 96-16. In March 2003, an amendment to the joint venture agreement was adopted, which removed the participating rights

of the minority partner. PETNET is now deemed to have control over the significant operating decisions of the joint venture and the entity is now consolidated in the Company’s financial statements effective March 1, 2003.

In cases where the minority shareholder is deemed to have “veto rights” or has equal representation on the board of directors, the Company accounts for these investments using the equity method as the Company does not have control over significant operating decisions. The Company has invested in four radiopharmacies that are accounted for under the equity method.

Revenue Recognition — The Company records revenues in accordance with the guidance of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101 (SAB 101), specifically when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the contract price is fixed or determinable, and collectibility is reasonably assured. No right of return privileges are granted to customers after shipment.

The Company accounts for sales of scanning equipment and related installation and associated training services as multiple-element arrangements. The Company recognizes revenue for the elements separately as (i) the sales of the equipment, installation and training services represent separate earnings processes, (ii) revenue is allocated among the elements based on the fair value of the elements and (iii) installation and associated training are not deemed essential to the functionality of the equipment (as other companies are available to provide the installation and associated training services and are sometimes employed by CTI to do so). The Company determines the value of the equipment and installation and training services based on sales of the equipment both with and without installation and training. The Company derives its revenues from sales of scanners, calibration sources, spare parts, detector materials, cyclotrons, radiopharmaceuticals and the provision of services on equipment sold, including site planning and installation, repair and maintenance, training, technical support and assistance with licensing. Revenues derived from the sale of scanners, calibration sources, spare parts, and detector materials are recognized upon either shipment or arrival at destination depending on shipment terms. During the three months ended March 31, 2003, the Company recognized revenue on the sale of one scanner which had not yet been shipped at the customer’s request. The terms and conditions of the sale met the requirements for revenue recognition and this sale had been paid in full by March 31, 2003.

Until April 2001, the Company’s scanners were distributed exclusively by Siemens. Under this exclusive distribution arrangement, the Company received and recognized revenue in an amount equal to the price to the customer and paid Siemens a fee to cover its selling, marketing, and distribution costs. Under this arrangement, the Company 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, the Company implemented a multiple distributor strategy for the sale of scanners by commencing direct distribution and by pursuing additional third-party distributor agreements. Following the implementation of the multiple distributor strategy, the Company received and recognized revenue in an amount equal to the price to the distributor and ceased paying fees to distributors to cover their selling, marketing, and distribution costs. Under these agreements, the Company set the transfer price to distributors who set their own prices to the end customer. The Company does not bear credit risk associated with the sales made by the distributors to end customers. Under the Company’s new distribution agreements for scanners, revenues are recognized upon delivery to our distributors when all other revenue recognition criteria have been met. Revenues derived from installing scanning equipment and associated training are deferred and recognized when installation and training are complete. For cyclotron system sales, all revenue is recognized upon installation and customer acceptance, as installation is deemed essential to the functionality of cyclotrons.

Revenues derived from distribution of radiopharmaceuticals are recognized upon delivery of the product. Equipment maintenance service contracts are typically three or more years in duration and related revenues are recognized ratably over the respective contract periods as the services are performed. For other services, revenue is recognized upon completion of the service.

The Company’s contracts require customer payments in advance of revenue recognition. These amounts are reflected as customer advances and recognized as revenue when the Company has fulfilled its obligations under the respective contracts.

Reclassifications – Certain amounts in the 2002 financial statements have been reclassified to conform to the 2003 presentation with no impact on previously reported retained earnings, net income or current or long-term balance sheet classifications.

Stock-Based Compensation – As permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation (SFAS 123), the Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its stock option plans.

Had compensation expense related to the Company’s outstanding options been determined based on the fair value at the grant dates consistent with SFAS 123, net income and earnings per share would be as reflected below:


		Three Months Ended						Six Months Ended
		March 31,						March 31,

(In thousands)		2003			2002			2003			2002

		(unaudited)						(unaudited)
Net income (loss), as reported		$	4,520		$	(11,844	)	$	7,904		$	(11,839	)
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects			263			6,926			692			7,028
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(824	)		(7,895	)		(1,748	)		(8,204	)

Pro forma Net income (loss)		$	3,959		$	(12,813	)	$	6,848		$	(13,015	)

Earnings per share:
	Basic - as reported		0.11			(0.46	)		0.19			(0.48	)
	Basic - pro forma		0.09			(0.49	)		0.16			(0.52	)
	Diluted - as reported		0.10			(0.46	)		0.17			(0.48	)
	Diluted - pro forma		0.08			(0.49	)		0.15			(0.52	)

Earnings per share - Basic earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding during the period. The weighted average number of common shares outstanding does not include unvested restricted shares. These shares, although classified as issued and outstanding, are considered contingently returnable until the restrictions lapse and will not be included in the basic earnings per share calculation until the shares are vested. Diluted earnings per share is computed by giving effect to all dilutive potential common shares, including restricted stock and stock options. A reconciliation of the numerator and denominator used in the calculation of historical basic and diluted earnings per share follows:


			Three Months Ended					Six Months Ended
			March 31,					March 31,

			2003		2002			2003		2002

			(unaudited)					(unaudited)
Numerator:
	Net income (loss) available to common shareholders — basic and diluted		$	4,520	$	(12,829	)	$	7,904	$	(13,391	)

Denominator:
	Weighted-average number of common shares outstanding			42,929,659		28,160,987			42,467,888		28,121,253

	Dilutive potential common shares relating to:
		Restricted stock		214,528		—			214,528		—
		Options		3,438,440		—			3,928,274		—

				3,652,968		—			4,142,802		—

Total weighted average number of shares used in computing diluted net income per share				46,582,627		28,160,987			46,610,690		28,121,253

The following amounts of outstanding warrants, convertible redeemable preferred stock, restricted stock and options were excluded from the computation of diluted net income per common share for the three month and six month periods ended March 31, 2003 and 2002 because including them would have had an antidilutive effect:


	Three Months Ended				Six Months Ended
	March 31,				March 31,

	2003		2002		2003		2002

	(unaudited)				(unaudited)
Warrants		—		2,365,608		—		2,406,843
Convertible redeemable preferred stock		—		1,280,000		—		1,280,000
Restricted stock		—		1,515,851		—		1,619,856
Options		1,674,850		4,528,190		1,624,208		4,352,674

		1,674,850		9,689,649		1,624,208		9,659,373

Recent Accounting Pronouncements

Asset Retirement - In August 2001 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, which is effective for fiscal years beginning after June 15, 2002. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Statement of Financial Accounting Standards No. 143 requires, among other things, that the retirement obligations be recognized when they are incurred and displayed as liabilities on the balance sheet. In addition, the asset’s retirement costs are to be capitalized as part of the asset’s carrying amount and subsequently recorded to expense over the asset’s useful life. The Company adopted Statement of Financial Accounting Standards No. 143 during the first quarter of fiscal year 2003 and this adoption had no significant impact on the Company’s financial statements.

Accounting for Impairment- In October 2001 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. This Statement develops one accounting model for long-lived assets that are to be disposed of by sale, as well as addressing the principal implementation issues. The Company adopted Statement of Financial Accounting Standards No. 144 in the first quarter of fiscal year 2003 and this adoption had no impact on the Company’s financial statements.

Sale Leaseback Transactions - In April 2002 FASB issued SFAS No. 145 (SFAS 145), Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, which is effective for transactions occurring after May 15, 2002 and fiscal nine months beginning after May 15, 2002. SFAS 145 rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements and amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The adoption of SFAS 145 will require CTI to reclassify the loss on early extinguishment of debt, previously recorded as extraordinary during the fourth quarter of fiscal year 2002, to other (income) expense in the Company’s future comparative financial statements.

Costs Associated with Exit or Disposal Activities - In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 146 (SFAS 146), Accounting for Costs Associated with Exit or Disposal Activities, which is effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. SFAS 146 addresses financial accounting and reporting for the costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Costs to Exit and Activity (Including Certain Costs Incurred in a Restructuring). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and establishes that fair value is the objective for initial measurement of the liability. The adoption of SFAS 146 had no significant impact on the Company’s financial statements.

Accounting for Revenue Arrangements with Multiple Deliverables — In November 2002, the Financial Accounting Standards Board reached a consensus on Emerging Issues Task Force Issue 00-21 (the Issue), Accounting for Revenue Arrangements with Multiple Deliverables. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. This Issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, this Issue addresses how to determine whether an arrangement involving multiple deliverables contains more than one earnings process and, if it does, how to divide the arrangement into separate units of accounting consistent with the identified earning processes for revenue recognition purposes. This Issue also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. The Company is evaluating the effect of this Issue on its financial statements.

Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others — On November 25, 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies (FAS 5), relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the entity (i.e., the guarantor) must recognize a liability for the fair value of the obligation it assumes under that guarantee. The FASB believes that, in current practice, many entities might not be recognizing that liability, believing that GAAP does not require recognition, particularly when the entity does not receive separately identifiable consideration (i.e., a premium) for issuing the guarantee. As noted above, many guarantees are embedded in purchase or sales agreements, service contracts, joint venture agreements, or other commercial agreements and the guarantor in many such arrangements does not receive a separately identifiable upfront payment for issuing the guarantee. FIN 45 is intended to improve the comparability of financial reporting by requiring identical accounting for guarantees issued with a separately identified premium and guarantees issued without a separately identified premium. FIN 45’s provisions for initial recognition and measurement should be applied on a prospective basis to guarantees issued or modified after December 31, 2002, regardless of the guarantor’s fiscal year-end. The guarantor’s previous accounting for guarantees that were issued before the date of FIN 45’s initial application may not be revised or restated to reflect the effect of the recognition and measurement provisions of FIN 45. The Company adopted the disclosure requirements of FIN 45 in the Company’s financial statements. Additional information about guarantees has been disclosed in the notes to the Company’s March 31, 2003 financial statements.

Consolidation of Variable Interest Entities - On January 17, 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. FIN 46 is an effort to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is any legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. The objective of FIN 46 is to improve financial reporting by companies involved with variable interest entities. Previously, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company is assessing the impact of FIN 46 on its unconsolidated investees and joint ventures, yet does not currently believe any qualify as variable interest entities.

Accounting for Stock-Based Compensation - On December 31, 2002 the FASB issued Statement of Financial Accounting Standard 148 (SFAS 148), Accounting for Stock-Based Compensation – Transition and Disclosure. SFAS 148 amends FASB Statement No. 123 (SFAS 123), Accounting for Stock-Based Compensation, to provide alternative methods of transition to SFAS 123’s fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 28, Interim Financial Reporting, to require the disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The Statement’s amendments of transition and annual disclosure requirements are effective for fiscal years ending after December 15, 2002, with earlier application permitted for entities with fiscal years ending prior to December 15, 2002. In addition, SFAS 148’s amendment of interim disclosure requirements is effective for interim periods beginning after December 15, 2002. The Company believes that the adoption of SFAS 148 will not have a significant impact on the Company’s financial statements. As now required by SFAS 148 additional information about stock options has been presented in the stock-based compensation accounting policy disclosure in the Company’s March 31, 2003 financial statements.

3. Inventories

Inventories consist of the following:


	March 31,		September 30,
(In thousands)	2003		2002

	(unaudited)
Component parts	$	32,729	$	19,410
Work in process		31,565		21,505
Finished goods		19,290		28,380

	$	83,584	$	69,295

Cyclotrons, which were delivered but not yet accepted by the customers, are included in inventories as finished goods in the condensed consolidated balance sheets at March 31, 2003 and September 30, 2002 in the amount of $3,128 (unaudited) and $5,978, respectively.

4. Property and Equipment

Property and equipment consist of the following:


	March 31,			September 30,
(In thousands)	2003			2002

	(unaudited)
Land	$	2,044		$	2,044
Buildings		9,417			9,417
Building and leasehold improvements		18,538			15,739
Machinery and equipment		67,432			54,994
Less accumulated depreciation		(26,801	)		(21,709	)
Assets under construction		24,947			17,182

Property and equipment, net	$	95,577		$	77,667

Depreciation expense for the three months ended March 31, 2003 and 2002 was $2,572 (unaudited) and $1,644 (unaudited), and for the six months ended March 31, 2003 and 2002 was $5,089 (unaudited) and $3,040 (unaudited), respectively.

Capital leases were used to finance the procurement of property and equipment in the amounts of $395 (unaudited) and $7,610 (unaudited) for the six months ended March 31, 2003 and 2002, respectively.

5. Commitments and Contingencies

CTI guarantees lease obligations for radiopharmacy facilities and equipment on behalf of unconsolidated investees in the maximum aggregate amount of $898 (unaudited) at March 31, 2003. No liability has been recorded for these lease obligations which expire through 2009. The guarantees are not collaterized by any assets, and are without recourse.

The Company provides a parts and labor warranty on products it distributes directly, typically for a period of twelve months after installation. Estimated costs of this warranty obligation are charged to cost of revenues at the time revenue is recognized. A summary of the activity in our warranty reserve is as follows:


	Six Months Ended
	March 31,

(In thousands)	2003			2002

	(unaudited)
Balance at the beginning of the period	$	3,740		$	3,433
Accruals for warranties issued during the period		1,925			3,156
Settlements made (in cash or in kind)		(2,523	)		(3,019	)

Balance at the end of the period	$	3,142		$	3,570

On November 21, 2002, General Electric Company filed an action against the Company 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. Because our investigation with respect to the allegations is at a preliminary stage, an estimate of the possible loss or range of loss, if any, cannot be made. Nevertheless, we deny liability and intend to vigorously defend this suit.

On September 19, 2002, General Electric filed a complaint against two former employees of General Electric who 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, and have denied liability.

In May 2002, Cox Nuclear Pharmacy, Inc. and Accuscan, L.L.C. filed an action against CTI, PETNET 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 fourteen causes of action against the defendants, including a breach of contract claim related to the sale of a cyclotron and various tort claims alleging misrepresentations in connection with the sale which generally relate to an alleged oral covenant not to compete with the plaintiffs. 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. The claims alleged against the PETNET employee were recently dismissed. CTI believes that the remaining claims are without merit and intends to vigorously defend this suit.

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.

6. Long-Term Debt

On September 30, 2002 CTI executed, and all of its subsidiaries guaranteed, an amended and restated syndicated revolving credit facility (the Syndicated Facility) with a group of banks. The modifications to the original $90,000 syndicated facility executed on March 14, 2002, primarily included increasing the total credit available to $125,000, decreasing the banks’ lending margin, reducing certain restrictive covenants, and extending the maturity. Borrowing under the Syndicated Facility is collateralized by all property and interests in property, presently owned or hereafter acquired or presently existing or hereafter created by CTI or its subsidiaries as guarantors, including any and all proceeds thereof, in which a security interest is now or hereinafter granted; provided, however, that all real property of CTI encumbered with an existing mortgage, as of March 14, 2002, is excluded; and provided further that the property and interests of CPS are limited to the inventory and accounts receivable and all proceeds therefrom of CPS. Interest is at LIBOR plus 0.75% to 1.75% or, at our option, the lender’s base rate plus 0.00% to 0.75%, payable monthly (2.59% at March 31, 2003). The Syndicated Facility matures on October 15, 2005 and contains certain restrictive covenants, which, among other things, require minimum tangible net worth, funded debt, and debt service ratios; impose limitations on other indebtedness and liens; and, restrict investments, disposals of assets and dividend payments. There was no outstanding balance of the Syndicated Facility at March 31, 2003 (unaudited).

Industrial Revenue Bonds — In 1988 ACT entered into an agreement with the Industrial Development Board of Blount County, Tennessee (the Board) relating to the issue of Industrial Development Revenue Bonds (the Series 1988 Bonds) by the Board in the aggregate principal amount of $5,000 for the purpose of lending proceeds from the Bonds to ACT. Such proceeds were restricted to use in the acquisition, construction, improvement, and equipping of a manufacturing plant in Blount County, Tennessee. The remaining $4,000 balance of the Series 1988 Bonds is supported by an irrevocable letter of credit agreement that expires in July 2004. The Series 1988 Bonds are due in August 2008.

On August 1, 2000 ACT entered into an agreement with the Board relating to the issue of Industrial Development Revenue Bonds (the Series 2000 Bonds) by the Board in the aggregate principal amount of $3,000 for the purpose of lending proceeds from the Series 2000 Bonds to the Company. Such proceeds are restricted to use in the acquisition, construction, improvement and equipping of the ACT manufacturing plant in Blount County, Tennessee. At March 31, 2003 the remaining $2,300 balance of the Series 2000 Bonds is supported by an irrevocable letter of credit agreement that expires in July 2004. The Series 2000 Bonds are due in August 2010. In May 2002, ACT redeemed all outstanding tax exempt bonds and reissued taxable bonds for the purpose of terminating federal government limitations on aggregate capital expenditures.

CTI is required to repay 10.0% of the outstanding debt annually, for both series. Both bond series bear interest at variable rates, which change from time to time as set by the remarketing agents for the bonds, in order to remarket both bond series in a secondary market (interest rates were from 1.35% to 1.40% at March 31, 2003).

Notes Payable — At March 31, 2003, CTI may borrow up to $7,900 under the terms of a construction loan agreement with a bank. Interest is payable monthly at LIBOR plus 1.00% to 2.00% after a modification executed in July 2002 (2.59% at March 31, 2003). Prior to the execution of the modification in July 2002, interest was payable monthly at LIBOR plus 1.25% to 2.25%. The outstanding balance on this construction loan agreement, which matures on May 31, 2004, was $7,831 (unaudited) at March 31, 2003.

During 2000, CTI entered into a mortgage loan agreement to purchase its current office space, which had previously been leased. CTI is required to make principal and interest payments totaling $720 per year through 2005. The debt bears interest at LIBOR plus 1.00% to 2.00% after a modification executed in July 2002, resulting in a rate of 2.59% at March 31, 2003. The outstanding balance on this mortgage loan was $3,636 (unaudited) at March 31, 2003.

7. Income Taxes

The Company files a consolidated federal tax return that includes all entities except its foreign subsidiary CTI GmbH, and joint venture entities such as CPS, where CTI does not have an 80% interest. CPS files a separate federal return and CTI GmbH files a German return. The Company’s effective tax rate on income before taxes and minority interest differs from the federal statutory rate as follows:


	Three Months Ended						Six Months Ended
	March 31,						March 31,

(In thousands)	2003			2002			2003			2002

	(unaudited)						(unaudited)
Federal tax @ 35%	$	4,351		$	(2,247	)	$	7,462		$	(813	)
State tax		292			(209	)		589			(76	)
Meals and entertainment		46			41			92			82
Extraterritorial income benefit		(132	)		—			(263	)		—
Warrant liability mark to market permanent difference		—			2,586			—			3,405
Stock-based compensation		9			2,004			88			2,004
Other permanent differences		28			—			118			—

Provision for income taxes	$	4,594		$	2,175		$	8,086		$	4,602

As a result of the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options, the Company has recorded an $8,050 (unaudited) tax benefit to additional paid in capital and as a reduction of income taxes payable during the quarter ended March 31, 2003.

8. Stock Options and Restricted Stock

Incentive Stock Option Plans

In 1998 the Company adopted an incentive stock option plan for officers and key employees. The options are generally exercisable in installments of 25% per year from the grant date, except that options granted to persons who, at the time of grant, have been employed by the Company for at least 10 years are fully exercisable upon grant. The options expire after five to seven years. Twelve million eight hundred thousand shares had been authorized under this plan; however, after the adoption of the 2002 Long-Term Incentive Plan in May 2002, no further awards will be granted under this plan. On May 23, 2002, the Company’s shareholders approved the 2002 Long-Term Incentive Plan which authorized three million shares.

The following table (unaudited) summarizes information about incentive stock options under both plans at March 31, 2003:


	Options Outstanding						Options Exercisable

	Number		Average		Average		Number		Average
Range of Exercise Prices	of Shares		Life⁽¹⁾		Price⁽²⁾		of Shares		Price⁽²⁾

$2.81		526,992		2.54	$	2.81		526,992	$	2.81
$3.09 to $3.87		389,734		3.55	$	3.40		385,289	$	3.39
$4.69		650,437		5.52	$	4.69		381,954	$	4.69
$5.56 to $6.12		570,176		5.90	$	5.60		309,383	$	5.63
$6.56		76,000		3.99	$	6.56		76,000	$	6.56
$15.55		25,720		9.32	$	15.55		6,430	$	15.55
$17.00		2,765		9.19	$	17.00		691	$	17.00
$18.37 to $18.80		33,531		9.95	$	18.37		6,706	$	18.37
$19.37 to $19.76		25,404		9.37	$	19.68		6,093	$	19.69
$21.97 to $22.40		74,675		9.66	$	21.79		16,721	$	22.09
$23.90		5,766		9.79	$	23.90		1,153	$	23.90
$25.00		45,500		9.70	$	25.00		9,100	$	25.00

		2,426,700			$	5.77		1,726,512	$	3.21

⁽¹⁾ Weighted average contractual life remaining in years.

⁽²⁾ Weighted average exercise price.

Non-qualified Options

In addition, the Company provides non-qualified stock options to certain officers and key employees. The options are generally exercisable in installments of 25% per year from the grant date, except that options granted to persons who, at the time of grant, have been employed by the Company for at least 10 years are fully exercisable upon grant. The options expire after five to ten years.

The following table (unaudited) summarizes information about non-qualified stock options at March 31, 2003:


	Options Outstanding						Options Exercisable

	Number		Average		Average		Number		Average
Range of Exercise Prices	of Shares		Life⁽¹⁾		Price⁽²⁾		of Shares		Price⁽²⁾

$0.16		6,400		1.20	$	0.16		6,400	$	0.16
$2.81 to $3.09		101,440		1.94	$	3.03		101,440	$	3.03
$3.52 to $4.69		224,893		5.65	$	4.65		54,759	$	4.52
$5.56		324,461		6.03	$	5.56		283,365	$	5.56
$15.55		574,280		9.32	$	15.55		143,570	$	15.55
$17.00		44,118		9.15	$	17.00		44,118	$	17.00
$19.76		303,847		9.36	$	19.76		75,962	$	19.76
$22.40		86,608		9.45	$	22.40		28,875	$	22.40
$25.00		2,000		9.70	$	25.00		400	$	25.00

		1,668,047			$	12.49		738,889	$	9.84

⁽¹⁾ Weighted average contractual life remaining in years.

⁽²⁾ Weighted average exercise price.

Stock-based Compensation

During the six months ended March 31, 2003, 2,000 options to purchase common stock were issued to non-employees. The fair value of these options of $26 was charged to stock-based compensation expense during the six months ended March 31, 2003, and was determined using the Black-Scholes option-pricing model.

During the year ended September 30, 2002, the Company issued options to purchase common stock with exercise prices ranging from $4.69 to $22.40. In connection with the issuance of these options to purchase common stock, the Company recorded unearned compensation of $4,441. The Company is amortizing the balance of unearned compensation over the respective vesting periods ranging from three to four years. For the three months and six months ended March 31, 2003, the Company amortized $79 (unaudited) and $364 (unaudited) to stock-based compensation expense, respectively. During the three months ended March 31, 2003 stock-based compensation expense was reduced by $204 (unaudited) due to forfeitures of options.

During the year ended September 30, 2002, the Company issued 214,528 restricted shares of common stock at prices ranging from $15.55 to $22.40 in connection with hiring executives. In connection with these restricted common shares, the Company recorded unearned compensation of $3,724. The Company is amortizing the balance to stock-based compensation expense over the four year vesting periods during which the restrictions expire. For the three months and six months ended March 31, 2003, the Company amortized $233 (unaudited) and $466 (unaudited) to stock-based compensation expense, respectively.

During the year ended September 30, 2002, the Company issued warrants to purchase common stock to a consultant in exchange for receiving consulting services. The fair value of the warrants was estimated using the Black-Scholes option-pricing model. In connection with the issuance of these warrants to purchase common stock, the Company recorded unearned compensation of $253. The Company is amortizing the balance of unearned compensation to stock-based compensation expense over the term of the consulting contract. For the three months and six months ended March 31, 2003, the Company amortized $13 (unaudited) and $25 (unaudited) to stock-based compensation expense, respectively.

9. Related Party Transactions

From 1987 through April 2001, Siemens was the exclusive distributor of scanners manufactured by CPS. In April 2001 CPS implemented a new multiple distributor strategy. The current distribution agreement with Siemens, which was effective March 1, 2002, has an initial term of five years with a one-year renewal period. The agreement is cancelable with three years notice upon the expiration of the then current term. Transfer prices are set annually and reviewed semi-annually and vary with product type and annual shipment volume. Sales are F.O.B. factory. Siemens is provided a warranty discount to cover their cost of parts during the first twelve months of usage. Siemens is responsible for all site planning, installation and customer training. The Company’s sales through and to Siemens were $37,131 (unaudited), and $27,342 (unaudited), during the three month periods ended March 31, 2003 and 2002, respectively, and $62,385 (unaudited) and $54,537 (unaudited) for the six month periods ended March 31, 2003 and 2002, respectively. Accounts receivable from Siemens totaled $31,193 (unaudited) and $39,918 at March 31, 2003 and September 30, 2002, respectively. Also, customer advances from Siemens totaled $1,201 (unaudited) and $1,214, at March 31, 2003 and September 30, 2002, respectively.

Under the terms of an agreement with Siemens (the Siemens Agreement), Siemens shall have the right to purchase, or CTI shall have the right to require Siemens to purchase, an additional 30.1% of CPS. The exercise of this put/call is contingent upon cumulative unit sales of ECAT® scanners reaching a defined target level. At March 31, 2003 (unaudited), the cumulative total number of units sold under the Siemens Agreement by the joint venture CPS was 593. By September 30, 2003, CPS would need to have sold a cumulative total of 981 units to achieve the required cumulative sales level for the put/call to be exercisable, with such cumulative unit sales requirement increasing by 74 units each year thereafter. Upon exercise of the put/call, the Siemens Agreement provides for the purchase price to be established through an independent third party valuation process if the parties are unable to agree upon a price. Once CTI is notified of Siemens’ intent to purchase the additional interest, CTI shall have the right to defer the Siemens purchase for one year. CTI does not expect this target level to be reached before 2005.

10. Segments

The Company operates in four reportable business segments based on differences in products and services: CPS, PETNET, Detector Materials, and CTI Services. CPS designs, manufactures and markets medical research and scanning equipment. PETNET manufactures and distributes radiopharmaceuticals to customers. Detector Materials manufactures a scintillation component sold primarily to CPS. The Company’s direct distribution and service of cyclotron systems and PET scanners are reflected in CTI Services.

The accounting policies of the segments are the same as those described in the “Summary of Significant Accounting Policies.” Segment data includes intersegment revenues. Assets and costs of the corporate headquarters are allocated to the segments based on usage with the exception of the Company’s headquarters building and non- allocable costs which are included in “Corporate and Other.” The Company evaluates the performance of its segments based on net income (loss). The Company’s business is conducted principally in the U.S.; however, the Company does have foreign operations for which identifiable assets are immaterial.

The following table summarizes information about net income (loss) and segment assets used by the chief operating decision maker of the Company in making decisions regarding allocation of assets and resources as of and for the three month period ended March 31, 2003 and 2002:


						Detector		CTI			Corporate			Eliminating			Consolidated
	CPS		PETNET			Materials		Services			and Other			Entries			Total

Three Months Ending March 31, 2003 (unaudited)
External revenues	$	40,618	$	17,297		$	1,089	$	22,960		$	—		$	—		$	81,964
Intersegment revenues		10,945		—			13,920		4,915			—			(29,780	)		—
Depreciation and amortization		262		1,609			379		158			483			(261	)		2,630
Stock-based compensation expense		61		(65	)		5		164			160			—			325
Interest expense		2		394			227		341			(471	)		—			493
Interest income		45		2			28		63			156			—			294
Equity in (income) losses of investees		—		(122	)		—		75			—			205			158
Income tax expense		3,854		(216	)		2,012		(745	)		423			(734	)		4,594
Minority interest expense		—		42			—		—			—			3,274			3,316
Net income (loss)		6,560		(459	)		3,146		(936	)		631			(4,422	)		4,520
Total assets		121,425		80,006			48,052		71,813			105,675			(46,069	)		380,902
Investment in equity method investees		—		1,167			—		943			—			—			2,110
Capital expenditures		2,701		6,155			494		360			2,215			(862	)		11,063
Three Months Ending March 31, 2002 (unaudited)
External revenues	$	35,788	$	13,037		$	144	$	6,289		$	—		$	—		$	55,258
Intersegment revenues		4,981		228			4,898		4,851			—			(14,958	)		—
Depreciation and amortization		197		982			195		153			312			(179	)		1,660
Stock-based compensation expense		—		—			—		—			8,134			—			8,134
Interest expense		147		595			226		197			(91	)		—			1,074
Interest income		—		3			46		87			(196	)		—			(60	)
Equity in (income) losses of investees		—		(82	)		—		39			—			18			(25	)
Income tax expense		4,104		49			365		(246	)		(2,164	)		67			2,175
Minority interest expense		—		24			—		—			—			3,225			3,249
Net income (loss)		6,464		(1,209	)		628		(626	)		(12,759	)		(4,342	)		(11,844	)
Total assets		101,357		54,428			29,681		47,807			23,702			(22,839	)		234,136
Investment in equity method investees		—		1,136			—		(42	)		—			—			1,094
Capital expenditures		313		6,057			24		357			3,772			(1,154	)		9,369


						Detector		CTI			Corporate			Eliminating			Consolidated
	CPS		PETNET			Materials		Services			and Other			Entries			Total

Six Months Ending March 31, 2003 (unaudited)
External revenues	$	72,537	$	33,371		$	1,588	$	35,027		$	—		$	—		$	142,523
Intersegment revenues		14,769		—			26,682		8,372			—			(49,823	)		—
Depreciation and amortization		621		3,096			780		298			931			(521	)		5,205
Stock-based compensation expense		158		86			10		307			320			—			881
Interest expense		3		767			495		707			(1,001	)		—			971
Interest income		217		3			59		149			268			—			696
Equity in (income) losses of investees		—		(309	)		—		140			—			174			5
Income tax expense		6,175		(420	)		3,577		(1,644	)		722			(324	)		8,086
Minority interest expense		—		83			—		—			—			5,246			5,329
Net income (loss)		10,513		(925	)		5,643		(2,673	)		924			(5,578	)		7,904
Total assets		121,425		80,006			48,052		71,813			105,675			(46,069	)		380,902
Investment in equity method investees		—		1,167			—		943			—			—			2,110
Capital expenditures		4,082		10,017			1,057		710			5,107			(1,462	)		19,511
Six Months Ending March 31, 2002 (unaudited)
External revenues	$	64,724	$	25,345		$	425	$	12,321		$	—		$	—		$	102,815
Intersegment revenues		6,525		228			10,189		7,106			—			(24,048	)		—
Depreciation and amortization		383		1,857			391		249			556			(374	)		3,062
Stock-based compensation expense		—		—			—		—			8,236			—			8,236
Interest expense		283		1,177			486		415			(39	)		—			2,322
Interest income		—		4			97		174			(249	)		—			26
Equity in (income) losses of investees		—		(364	)		—		154			—			—			(210	)
Income tax expense		6,030		28			906		(419	)		(2,136	)		193			4,602
Minority interest expense		—		33			—		—			—			4,882			4,915
Net income (loss)		9,784		(1,439	)		1,546		(1,198	)		(14,941	)		(5,591	)		(11,839	)
Total assets		101,357		54,428			29,681		47,807			23,702			(22,839	)		234,136
Investment in equity method investees		—		1,136			—		(42	)		—			—			1,094
Capital expenditures		506		9,767			365		2,397			5,074			(1,154	)		16,955

Sales were distributed to the following locations:


	Three Months Ended						Six Months Ended
	March 31,						March 31,
	2003			2002			2003			2002

	(unaudited )						(unaudited )
United States		66.9	%		63.4	%		74.5	%		72.8	%
Foreign		33.1			36.6			25.5			27.2

		100.0	%		100.0	%		100.0	%		100.0	%

ITEM 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

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.

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, radiopharmaceutical manufacturing and distribution and related support services.

Historically, the majority of our consolidated revenues, gross margin and net income have been attributable to CTI PET Systems, Inc., doing business as CPS Innovations (CPS). 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 Medical Solutions USA, Inc. (Siemens), a wholly owned subsidiary of Siemens A.G., could first close on the exercise of its option to purchase a controlling interest in CPS. 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.

Segments

We operate in four segments for financial reporting purposes: CPS; PETNET; Detector Materials, and CTI Services.

CPS

Our CPS segment includes the development, production and sale of PET and PET/CT scanners. We conduct this business through our subsidiary, CPS, which was formed in 1987 as a joint venture with Siemens. We own 50.1% of CPS and Siemens owns the remaining 49.9%.

From 1987 until April 2001, the products of CPS were distributed exclusively by Siemens. Under this distribution agreement, CPS 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, CPS 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 CPS by commencing direct distribution through our CTI Services segment and by pursuing additional third-party distributor agreements. In November 2001 CPS added Hitachi Medical Systems America, Inc. as a third-party distributor of its products. Following our implementation of the multiple distributor strategy, CPS began receiving and recording revenue from sales made through third-party distributors in an amount equal to the price to the distributor and ceased paying fees to distributors to cover their selling, marketing and distribution costs. Under these agreements, CPS sets the price to distributors who set their own price to the end customer. CPS does not bear credit risk associated with sales made by the distributor to end customers.

The scanners manufactured by CPS 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.

PETNET

Our PETNET segment consists of our business of developing, manufacturing 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 36 PETNET radiopharmacies in the U.S. and one 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 37 radiopharmacies PETNET operates also include three radiopharmacies we do not consolidate, as the Company does not have control over significant operating decisions.

Detector Materials

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

Our CTI Detector Materials division has certain exclusive rights to the development and manufacturing of our current generation detector material called lutetium oxyorthosilicate, or LSO. We obtained an exclusive license from Schlumberger Technology Corporation with respect to LSO 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 our Detector Materials segment in order to meet an expected increase in demand for detector materials as the PET market continues to grow. ACT manufactures bismuth germanate, or BGO, a primary detector material used in PET scanners.

CTI Services

Our CTI Services segment includes CTI’s division that distributes and installs PET scanners manufactured by CPS; 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.

Components of Revenues and Expenses

Revenues

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 CPS 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. Revenues for the distribution of radiopharmaceuticals are recognized upon delivery of the product. Revenue for service contracts is recognized ratably over the period in which the service is provided.

Cost of Revenues

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 37 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.

Operating Expenses

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 invested in product development; legal costs associated with filing of patents and regulatory matters; and research grants and consulting fees to various third parties.

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.


			Three Months Ended						Six Months Ended
			March 31,						March 31,

			2003			2002			2003			2002

			(unaudited)						(unaudited)
Revenues:
	CPS		$	51.6		$	40.7		$	87.3		$	71.2
	PETNET			17.2			13.3			33.3			25.6
	Detector materials			15.0			5.1			28.3			10.6
	CTI Services			27.9			11.1			43.4			19.4
	Intercompany eliminations			(29.8	)		(14.9	)		(49.8	)		(24.0	)

		Total		81.9			55.3			142.5			102.8

Cost of revenues:
	CPS			33.5			24.0			56.3			43.0
	PETNET			12.3			10.5			23.4			20.3
	Detector materials			8.6			3.4			16.8			6.7
	CTI Services			23.0			8.5			34.7			14.3
	Intercompany eliminations			(28.1	)		(13.8	)		(49.2	)		(23.3	)

		Total		49.3			32.6			82.0			61.0

Selling, general and administrative expenses:
	CPS			2.6			2.6			5.1			5.5
	PETNET			3.9			2.7			7.7			4.5
	Detector materials			0.9			0.3			1.3			0.5
	CTI Services			5.2			2.9			10.4			5.2
	Corporate and Other			(0.2	)		—			0.1			—

		Total		12.4			8.5			24.6			15.7

Research and development expenses:
	CPS			4.9			3.4			9.1			6.6
	PETNET			1.5			0.6			2.8			1.1
	Detector materials			0.2			0.2			0.5			0.4
	CTI Services			0.9			0.6			1.7			1.3

		Total		7.5			4.8			14.1			9.4

Stock-based compensation:
	CPS			0.1			—			0.2			—
	PETNET			(0.1	)		—			0.1			—
	CTI Services			0.2			—			0.3			—
	Corporate and Other			0.1			8.1			0.3			8.2

		Total		0.3			8.1			0.9			8.2

Income (loss) from operations:
	CPS			10.5			10.7			16.6			16.1
	PETNET			(0.4	)		(0.5	)		(0.7	)		(0.3	)
	Detector materials			5.3			1.2			9.7			3.0
	CTI Services			(1.4	)		(0.9	)		(3.7	)		(1.4	)
	Corporate and Other			(1.6	)		(9.2	)		(1.0	)		(8.9	)

		Total	$	12.4		$	1.3		$	20.9		$	8.5

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


		Three Months Ended						Six Months Ended
		March 31,						March 31,

		2003			2002			2003			2002

		(unaudited)						(unaudited)
CPS:
	Revenues		100.0	%		100.0	%		100.0	%		100.0	%
	Cost of revenues		64.9			59.0			64.5			60.4
	Selling, general and administrative		5.0			6.4			5.9			7.7
	Research and development		9.5			8.3			10.4			9.3
	Stock-based compensation		0.2			0.0			0.2			0.0
	Income (loss) from operations		20.4			26.3			19.0			22.6
PETNET:
	Revenues		100.0	%		100.0	%		100.0	%		100.0	%
	Cost of revenues		71.5			78.9			70.3			79.3
	Selling, general and administrative		22.7			20.3			23.1			17.6
	Research and development		8.7			4.5			8.4			4.3
	Stock-based compensation		(0.6	)		0.0			0.3			0.0
	Income (loss) from operations		(2.3	)		(3.7	)		(2.1	)		(1.2	)
Detector Materials:
	Revenues		100.0	%		100.0	%		100.0	%		100.0	%
	Cost of revenues		57.4			66.7			59.3			63.2
	Selling, general and administrative		6.0			5.9			4.6			4.7
	Research and development		1.3			3.9			1.8			3.8
	Income (loss) from operations		35.3			23.5			34.3			28.3
CTI Services:
	Revenues		100.0	%		100.0	%		100.0	%		100.0	%
	Cost of revenues		82.4			76.6			80.0			73.7
	Selling, general and administrative		18.7			26.1			23.9			26.8
	Research and development		3.2			5.4			3.9			6.7
	Stock-based compensation		0.7			0.0			0.7			0.0
	Income (loss) from operations		(5.0	)		(8.1	)		(8.5	)		(7.2	)

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.


			Three Months Ended						Six Months Ended
			March 31,						March 31,

			2003			2002			2003			2002

			(unaudited)						(unaudited)
Revenues:
	CPS			63.0	%		73.6	%		61.3	%		69.3	%
	PETNET			21.0			24.0			23.4			24.9
	Detector materials			18.3			9.2			19.8			10.3
	CTI Services			34.1			20.1			30.4			18.8
	Intercompany eliminations			(36.4	)		(26.9	)		(34.9	)		(23.3	)

		Total		100.0	%		100.0	%		100.0	%		100.0	%

Income (loss) from operations:
	CPS			84.7	%		823.1	%		79.4			189.4
	PETNET			(3.2	)		(38.5	)		(3.3	)		(3.5	)
	Detector materials			42.7			92.3			46.4			35.3
	CTI Services			(11.3	)		(69.2	)		(17.7	)		(16.5	)
	Corporate and Other			(12.9	)		(707.7	)		(4.8	)		(104.7	)

		Total		100.0	%		100.0	%		100.0	%		100.0	%

Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002

Revenues

Revenues for the three months ended March 31, 2003 were $81.9 million, an increase of $26.6 million, or 48.1%, from $55.3 million in 2002.

CPS. Revenues for the three months ended March 31, 2003 were $51.6 million, an increase of $10.9 million, or 26.8%, from $40.7 million for the three months ended March 31, 2002. The increase in revenues was driven primarily by an increase in unit sales of scanners from 29 units in 2002 to 43 units in 2003. The increase in unit sales was partially offset by a decline in average unit prices, primarily due to the new multiple distributor arrangement, whereby CPS now recognizes revenue in an amount equal to the transfer price to the distributors and has ceased paying fees to distributors to cover their selling, marketing, and distribution costs. Intersegment revenues accounted for 21.2% and 12.2% of total CPS revenues for the three months ended March 31, 2003 and 2002, respectively. The increase in intersegment revenues resulted from increased sales through CTI Services under the new multiple distributor arrangement.

PETNET. Revenues for the three months ended March 31, 2003 were $17.2 million, an increase of $3.9 million, or 29.3%, from $13.3 million for the three months ended March 31, 2002. The increase in revenue was due to the growth of dose shipments driven by continued increase in PET utilization as well as the opening of new PETNET radiopharmacies. PETNET delivered approximately 57.5% more doses, excluding doses sold to hosts and doses sold by unconsolidated radiopharmacies, during the three months ended March 31, 2003 compared to the three months ended March 31, 2002. The increase in revenues resulting from the increase in doses delivered was partially offset by a decrease in average revenue per dose. PETNET had no intersegment sales for the three months ended March 31, 2003. Intersegment revenues accounted for 1.7% of total PETNET revenues for the three months ended March 31, 2002.

Detector Materials. Revenues for the three months ended March 31, 2003 were $15.0 million, an increase of $9.9 million, or 194.1%, from $5.1 million for the three months ended March 31, 2002. The growth in revenues was primarily due to growth in intercompany sales of LSO detector material to CPS in conjunction with the increased shipment volume of LSO-based scanners. Intersegment sales accounted for 92.7% and 97.1% of total detector materials revenues for the three months ended March 31, 2003 and 2002, respectively.

CTI Services. Revenues for the three months ended March 31, 2003 were $27.9 million, an increase of $16.8 million, or 151.4%, from $11.1 million for the three months ended March 31, 2002. The increase in revenues was primarily due to an increase in direct distribution sales of PET scanners by CTI, purchased from CPS. Intersegment revenues which represent the sale of cyclotrons to PETNET, accounted for 17.6% and 43.5% of total CTI Services revenues for the three months ended March 31, 2003, and 2002, respectively. Intersegment revenues decreased as a percentage of revenues due to an increase in third-party sales of PET scanners through CTI Services’ direct distribution efforts.

Intercompany Eliminations. Intercompany revenues that were eliminated in consolidation for the three months ended March 31, 2003 were $29.8 million, an increase of $14.9 million, or 100%, from $14.9 million for the three months ended March 31, 2002. The increase in revenue eliminations was primarily due to increased sales of detector materials to CPS, as well as increased sales of PET scanners to CTI Services from CPS.

Cost of Revenues

Cost of revenues for the three months ended March 31, 2003 was $49.3 million, an increase of $16.7 million, or 51.2%, from $32.6 million for the three months ended March 31, 2002. Cost of revenues for the three months ended March 31, 2003 was 60.2% of revenues compared to 59.0% for the three months ended March 31, 2002.

CPS. Cost of revenues for the three months ended March 31, 2003 was $33.5 million, an increase of $9.5 million, or 39.6%, from $24.0 million for the three months ended March 31, 2002. Cost of revenues for the three months ended March 31, 2003 increased to 64.9% of revenues compared to 59.0% of revenues for the three months ended March 31, 2002. The increase in cost of revenues as a percentage of revenues is primarily due to lower transfer prices on units sold under our new multiple distributor arrangement and higher manufacturing costs of the PET/CT scanner.

PETNET. Cost of revenues for the three months ended March 31, 2003 was $12.3 million, an increase of $1.8 million, or 17.1%, from $10.5 million for the three months ended March 31, 2002. The increase in cost of revenues was due primarily to an increase in sales volume. Cost of revenues for the three months ended March 31, 2003 decreased to 71.5% of revenues compared to 78.9% of revenues for the three months ended March 31, 2002. The decrease in cost of revenues as a percentage of revenues was due to higher utilization of production and distribution resources to support the increase in the volume of doses delivered.

Detector Materials. Cost of revenues for the three months ended March 31, 2003 was $8.6 million, an increase of $5.2 million, or 152.9%, from $3.4 million for the three months ended March 31, 2002. Cost of revenues for the three months ended March 31, 2003 decreased to 57.4% of revenues as compared to 66.7% of revenues for the three months ended March 31, 2002. The decrease in cost of revenues as a percentage of revenues was due to increasing efficiency and production improvements concurrent with the ramp up of manufacturing operations to meet the growing demand for LSO based detector materials.

CTI Services. Cost of revenues for the three months ended March 31, 2003 was $23.0 million, an increase of $14.5 million, or 170.6%, from $8.5 million for the three months ended March 31, 2002. Cost of revenues for the three months ended March 31, 2003 was 82.4% of revenues compared to 76.6% of revenues for 2002. The increase in cost of revenues as a percentage of revenues results from a shift in sales mix to direct distribution of PET scanners purchased from CPS. The percentage of CTI Services’ sales coming from the direct distribution of scanners purchased from CPS, which business carries a lower gross margin than cyclotrons or service contracts, increased in 2003 over 2002.

Intercompany Eliminations. Intercompany cost of revenues that were eliminated in consolidation for the three months ended March 31, 2003 were $28.1 million, an increase of $14.3 million, or 103.6%, from $13.8 million for the three months ended March 31, 2002. Cost of revenues eliminated for the three months ended March 31, 2003 were 34.3% of revenues compared to 25.0% of revenues for 2002. The increase in intercompany eliminations as a percentage of revenues primarily results from the increase in direct distribution sales from CPS to CTI Services and from the increase in LSO based detector materials sales from Detector Materials to CPS.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months ended March 31, 2003 were $12.4 million, an increase of $3.9 million, or 45.9%, from $8.5 million for the three months ended March 31, 2002. Selling, general and administrative expenses for the three months ended March 31, 2003 were 15.1% of revenues compared to 15.4% of revenues for the three months ended March 31, 2002.

CPS. Selling, general and administrative expenses were $2.6 million for the three months ended March 31, 2003 and 2002. Selling, general and administrative expenses for the three months ended March 31, 2003 were 5.0% of revenues compared to 6.4% of revenues for the three months ended March 31, 2002. The decrease was due to the impact of the new distribution arrangements implemented in connection with the multiple distributor strategy, pursuant to which all of the selling costs and a substantial part of the marketing costs shifted from CPS to its distributors.

PETNET. Selling, general and administrative expenses for the three months ended March 31, 2003 were $3.9 million, an increase of $1.2 million, or 44.4%, from $2.7 million for the three months ended March 31, 2002. Selling, general, and administrative expenses for the three months ended March 31, 2003 were 22.7% of revenues compared to 20.3% of revenues for the three months ended March 31, 2002. The increase in selling, general and administrative expenses was due to the addition of sales and marketing personnel.

Detector Materials. Selling, general and administrative expenses for the three months ended March 31, 2003 were $0.9 million, an increase of $0.6 million, or 200.0%, from $0.3 million for the three months ended March 31, 2002. As a percentage of revenues, selling, general and administrative expenses were 6.0% and 5.9% for the three months ended March 31, 2003 and 2002, respectively. The increase is primarily related to increased administrative expenses to support significant sales growth.

CTI Services. Selling, general and administrative expenses for the three months ended March 31, 2003 were $5.2 million, an increase of $2.3 million, or 79.3%, from $2.9 million for the three months ended March 31, 2002. As a percentage of revenues, selling, general and administrative expenses for the three months ended March 31, 2003 were 18.7% compared to 26.1% for 2002. A significant portion of this relative percentage decrease was related to an increase in revenues from the direct distribution of PET scanners purchased from CPS.

Corporate and Other. Selling, general and administrative expenses not charged to other financial reporting segments for the three months ended March 31, 2003 were $(0.2) million, compared to none for the three months ended March 31, 2002.

Research and Development Expenses

Research and development expenses for the three months ended March 31, 2003 were $7.5 million, an increase of $2.7 million, or 56.3%, from $4.8 million for the three months ended March 31, 2002. Research and development expenses for the three months ended March 31, 2003 were 9.2% of revenues compared to 8.7% for the three months ended March 31, 2002.

CPS. Research and development expenses for the three months ended March 31, 2003 were $4.9 million, an increase of $1.5 million, or 44.1%, from $3.4 million for the three months ended March 31, 2002. Research and development expenses for the three months ended March 31, 2003 were 9.5% of revenues compared to 8.3% for the three months ended March 31, 2002. The increase resulted from additional investments in new scanner technology, which investments were primarily devoted to PET/CT and LSO scanner developments.

PETNET. Research and development expenses for the three months ended March 31, 2003 were $1.5 million, an increase of $0.9 million, or 150.0%, from $0.6 million for the three months ended March 31, 2002. Research and development expenses for 2003 and 2002 were 8.7% and 4.5% of revenues, respectively. The increase was due to increased investment in radiopharmaceutical research and development, which resulted in the addition of personnel and consulting expenses. We expect research and development expenses in our PETNET segment to increase as we pursue the development of new radiopharmaceuticals.

Detector Materials. Research and development expenses for both the three months ended March 31, 2003 and 2002 were $0.2 million. Detector Materials continues to invest in LSO technology to support LSO scanner developments by CPS. Research and development expenses for the three months ended March 31, 2003 were 1.3% of revenues compared to 3.9% for the three months ended March 31, 2002. The relative percentage decrease resulted from the significant increase in revenues.

CTI Services. Research and development expenses for the three months ended March 31, 2003 were $0.9 million, an increase of $0.3 million, or 50.0%, from $0.6 million for the three months ended March 31, 2002. Research and development expenses for the three months ended March 31, 2003 were 3.2% of revenues compared to 5.4% for the three months ended March 31, 2002. The relative percentage decrease primarily resulted from the significant increase in revenues.

Stock-based Compensation Expense

Stock-based compensation expense for the three months ended March 31, 2003 was $0.3 million, a decrease of $7.8 million, or 96.3%, from $8.1 million for the three months ended March 31, 2002, and resulted from 2003 including the amortization of unearned compensation arising from the pre-IPO issuance of stock options with exercise prices below the fair market value of our common stock on the grant dates. Stock-based compensation expense for the three months ended March 31, 2003 was 0.4% of revenues compared to 14.6% for the three months ended March 31, 2002.

CPS. Stock-based compensation expense for the three months ended March 31, 2003 was $0.1 million, compared to none for the three months ended March 31, 2002. Stock-based compensation expense for the three months ended March 31, 2003 was 0.2% of revenues.

PETNET. Stock-based compensation expense for the three months ended March 31, 2003 was $(0.1) million after deducting $0.2 million in prior charges currently reversed due to forfeitures, compared to none for the three months ended March 31, 2002. Stock-based compensation expense for the three months ended March 31, 2003 was (0.6)% of revenues.

Detector Materials. No stock-based compensation expense was incurred for the three months ended March 31, 2003 and 2002.

CTI Services. Stock-based compensation expense for the three months ended March 31, 2003 was $0.2 million, compared to none for the three months ended March 31, 2002. Stock-based compensation expense for the three months ended March 31, 2003 was 0.7% of revenues compared to none for the three months ended March 31, 2002.

Corporate and Other. Stock-based compensation expense not charged to other financial reporting segments for the three months ended March 31, 2003 was $0.1 million, a decrease of $8.0 million, or 98.8%, from $8.1 million for the three months ended March 31, 2002.

Income (Loss) from Operations

Income from operations for the three months ended March 31, 2003 was $12.4 million, an increase of $11.1 million, or 853.8%, from $1.3 million for the three months ended March 31, 2002. Income from operations for the three months ended March 31, 2003 was 15.1% of revenues compared to 2.4% for the three months ended March 31, 2002.

CPS. Income from operations for the three months ended March 31, 2003 was $10.5 million, a decrease of $0.2 million, or 1.9%, from $10.7 million for the three months ended March 31, 2002. Income from operations for the three months ended March 31, 2003 was 20.4% of revenues compared to 26.3% for the three months ended March 31, 2002. This decrease in operating profit margins results primarily from the increased spending in research and development during the three months ended March 31, 2003.

PETNET. Loss from operations for the three months ended March 31, 2003 was $0.4 million, a decrease of $0.1 million, or 20.0%, from a loss of $0.5 million for the three months ended March 31, 2002. Loss from operations for the three months ended March 31, 2003 was 2.3% of revenues, compared to 3.7% of revenues for the three months ended March 31, 2002. The operating loss is primarily the result of increased selling, general and administrative and research and development expenses.

Detector Materials. Income from operations for the three months ended March 31, 2003 was $5.3 million, an increase of $4.1 million, or 341.7%, from $1.2 million for the three months ended March 31, 2002. The increase was primarily the result of growth in intercompany sales of LSO detector materials to CPS in conjunction with the increased shipment volume of LSO based scanners. Income from operations for the three months ended March 31, 2003 was 35.3% of revenues compared to 23.5% for the three months ended March 31, 2002.

CTI Services. Loss from operations for the three months ended March 31, 2003 was $1.4 million, an increase of $0.5 million, or 55.6%, from a loss of $0.9 million for the three months ended March 31, 2002. The loss from operations for the three months ended March 31, 2002 was primarily due to developing our business as a direct distributor of PET scanners. Loss from operations for the three months ended March 31, 2003 was 5.0% of revenues compared to 8.1% for the three months ended March 31, 2002.

Corporate and Other. Loss from operations for the three months ended March 31, 2003 was $1.6 million, a decrease of $7.6 million, or 82.6%, from $9.2 million for the three months ended March 31, 2002. The decrease in the operating loss primarily resulted from the decrease in stock-based compensation expenses.

Interest Expense, Net

Interest expense for the three months ended March 31, 2003 was $0.2 million, a decrease of $0.9 million, or 81.8%, from $1.1 million for the three months ended March, 31, 2002, resulting from substantial long-term debt repayments and an increase in cash and marketable securities after our initial public offering in June 2002.

Provision for Income Taxes

The income tax provision for the three months ended March 31, 2003 was $4.6 million, an increase of $2.4 million, or 109.1%, from $2.2 million for the three months ended March 31, 2002. The effective tax rate for the three month period ended March 31, 2003 was 37.0%. The income tax provision for the three months ended March 31, 2002, was $2.2 million despite the pretax loss of $6.4 million as the stock-based compensation and warrant liability mark to market charges are not tax deductible.

Minority Interests

The minority interest expense for the three months ended March 31, 2003 was $3.3 million an increase of $0.1 million, or 3.1% from $3.2 million for the three months ended March 31, 2002. The increase is due to the increase in the net income of CPS.

Six Months Ended March 31, 2003 Compared to Six Months Ended March 31, 2002

Revenues

Revenues for the six months ended March 31, 2003 were $142.5 million, an increase of $39.7 million, or 38.6%, from $102.8 million for the six months ended March 31, 2002.

CPS. Revenues for the six months ended March 31, 2003 were $87.3 million, an increase of $16.1 million, or 22.6%, from $71.2 million for the six months ended March 31, 2002. The increase in revenues was driven primarily by an increase in unit sales of scanners from 49 units in 2002 to 71 units in 2003. The increase in unit sales was partially offset by a decline in average unit prices, primarily due to the new multiple distributor arrangement, whereby CPS now recognizes revenue in an amount equal to the transfer price to the distributors and has ceased paying fees to distributors to cover their selling, marketing, and distribution costs. Intersegment revenues accounted for 16.9% and 9.2% of total CPS revenues for the six months ended March 31, 2003 and 2002, respectively. The increase in intersegment revenues resulted from increased sales to CTI Services under the new multiple distributor arrangement.

PETNET. Revenues for the six months ended March 31, 2003 were $33.3 million, an increase of $7.7 million, or 30.1%, from $25.6 million for the six months ended March 31, 2002. The increase in revenue was due to the growth of dose shipments driven by the continued increase in PET utilization as well as the opening of new PETNET radiopharmacies. PETNET delivered approximately 61.3% more doses, excluding doses sold to hosts and doses sold by unconsolidated radiopharmacies, during the six months ended March 31, 2003 compared to the six months ended March 31, 2002. The increase in revenues resulting from the increase in doses delivered was partially offset by a decrease in average revenue per dose. Intersegment revenues are not significant for PETNET.

Detector Materials. Revenues for the six months ended March 31, 2003 were $28.3 million, an increase of $17.7 million, or 167.0%, from $10.6 million for the six months ended March 31, 2002. The growth in revenues was primarily due to growth in intercompany sales of LSO detector material to CPS in conjunction with the increased shipment volume of LSO-based scanners. Intersegment sales accounted for 94.4% and 96.0% of total detector materials revenues for the six months ended March 31, 2003 and 2002, respectively.

CTI Services. Revenues for the six months ended March 31, 2003 were $43.4 million, an increase of $24.0 million, or 123.7%, from $19.4 million for the six months ended March 31, 2002. The increase in revenues was primarily due to an increase in direct distribution sales of PET scanners by CTI, purchased from CPS. Intersegment revenues accounted for 19.3% and 36.6% of total CTI Services revenues for the six months ended March 31, 2003 and 2002, respectively. Intersegment revenues decreased as a percentage of revenues due to an increase in third-party sales of PET scanners under CTI Services’ direct distribution efforts.

Intercompany Eliminations. Intercompany revenues that were eliminated in consolidation for the six months ended March 31, 2003 were $49.8 million, an increase of $25.8 million, or 107.5%, from $24.0 million for the six months ended March 31, 2002. The increase in revenue eliminations was primarily due to increased sales of detector materials to CPS, as well as increased sales of PET scanners to CTI Services from CPS.

Cost of Revenues

Cost of revenues for the six months ended March 31, 2003 was $82.0 million, an increase of $21.0 million, or 34.4%, from $61.0 million for the six months ended March 31, 2002. Cost of revenues for the six months ended March 31, 2003 was 57.5% of revenues compared to 59.3% for the six months ended March 31, 2002.

CPS. Cost of revenues for the six months ended March 31, 2003 was $56.3 million, an increase of $13.3 million, or 30.9%, from $43.0 million for the six months ended March 31, 2002. Cost of revenues for the six months ended March 31, 2003 increased to 64.5% of revenues compared to 60.4% of revenues for the six months ended March 31, 2002. The increase in cost of revenues as a percentage of revenues is primarily due to lower transfer prices on units sold under our new multiple distributor arrangement and higher manufacturing costs of the PET/CT scanner.

PETNET. Cost of revenues for the six months ended March 31, 2003 was $23.4 million, an increase of $3.1 million, or 15.3%, from $20.3 million for the six months ended March 31, 2002. The increase in cost of revenues was due primarily to an increase in sales volume. Cost of revenues for the six months ended March 31, 2003 decreased to 70.3% of revenues compared to 79.3% of revenues for the six months ended March 31, 2002. The decrease in cost of revenues as a percentage of revenues was due to higher utilization of production and distribution resources to support the increase in the volume of doses delivered.

Detector Materials. Cost of revenues for the six months ended March 31, 2003 was $16.8 million, an increase of $10.1 million, or 150.7%, from $6.7 million for the six months ended March 31, 2002. Cost of revenues for the six months ended March 31, 2003 decreased to 59.3% of revenues as compared to 63.2% of revenues for the six months ended March 31, 2002. The decrease in cost of revenues as a percentage of revenues was due to a increased efficiency and improved manufacturing processes concurrent with the ramp up of manufacturing operations to meet the growing demand for LSO based detector materials.

CTI Services. Cost of revenues for the six months ended March 31, 2003 was $34.7 million, an increase of $20.4 million, or 142.7%, from $14.3 million for the six months ended March 31, 2002. Cost of revenues for the six months ended March 31, 2003 was 80.0% of revenues compared to 73.7% of revenues for the six months ended March 31, 2002. The increase in cost of revenues as a percentage of revenues results from a shift in sales mix to direct distribution of PET scanners purchased from CPS. The percentage of CTI Services’ sales coming from the direct distribution of PET scanners purchased from CPS, which business carries a lower gross margin than cyclotrons or service contracts, increased in 2003 over 2002.

Intercompany Eliminations. Intercompany cost of revenues that were eliminated in consolidation for the six months ended March 31, 2003 were $49.2 million, an increase of $25.9 million, or 111.2%, from $23.3 million for the six months ended March 31, 2002. Cost of revenues eliminated for the six months ended March 31, 2003 were 34.5% of revenues compared to 22.7% of revenues for the six months ended March 31, 2002. The increase in intercompany eliminations as a percentage of revenues primarily results from the increase in direct distribution sales from CPS to CTI Services and from the increase in LSO based detector materials sales from Detector Materials to CPS.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the six months ended March 31, 2003 were $24.6 million, an increase of $8.9 million, or 56.7%, from $15.7 million for the six months ended March 31, 2002. Selling, general and administrative expenses for the six months ended March 31, 2003 were 17.3% of revenues compared to 15.3% of revenues for the six months ended March 31, 2002. A significant portion of this increase is due to the expansion of the direct distribution sales organization in CTI Services, and employing a contract sales force in PETNET.

CPS. Selling, general and administrative expenses for the six months ended March 31, 2003 were $5.1 million, a decrease of $0.4 million, or 7.3%, from $5.5 million for the six months ended March 31, 2002. Selling, general and administrative expenses for 2003 were 5.9% of revenues compared to 7.7% of revenues for the six months ended March 31, 2002. The decrease was due to the impact of the new distribution arrangements implemented in connection with the multiple distributor strategy, pursuant to which all of the selling costs and a substantial part of the marketing costs shifted from CPS to its distributors.

PETNET. Selling, general and administrative expenses for the six months ended March 31, 2003 were $7.7 million, an increase of $3.2 million, or 71.1%, from $4.5 million for the six months ended March 31, 2002. Selling, general, and administrative expenses for the six months ended March 31, 2003 were 23.1% of revenues compared to 17.6% of revenues for the six months ended March 31, 2002. The increase in selling, general and administrative expenses was due to the addition of sales and marketing personnel.

Detector Materials. Selling, general and administrative expenses for the six months ended March 31, 2003 were $1.3 million, an increase of $0.8 million, or 160.0%, from $0.5 million for the six months ended March 31, 2002. The increase was due to increased administrative expenses to support significant sales growth. As a percentage of revenues, selling, general and administrative expenses were 4.6% and 4.7% for the six months ended March 31, 2003 and 2002, respectively.

CTI Services. Selling, general and administrative expenses for the six months ended March 31, 2003 were $10.4 million, an increase of $5.2 million, or 100.0%, from $5.2 million for the six months ended March 31, 2002. As a percentage of revenues, selling, general and administrative expenses for the six months ended March 31, 2003 were 23.9% compared to 26.8% for the six months ended March 31, 2002. A significant portion of this decrease was related to an increase in revenues due to an increase in direct distribution sales of PET scanners, purchased from CPS.

Corporate and Other. Selling, general and administrative expenses not charged to other financial reporting segments for the six months ended March 31, 2003 were $0.1 million, compared to none for the six months ended March 31, 2002.

Research and Development Expenses

Research and development expenses for the six months ended March 31, 2003 were $14.1 million, an increase of $4.7 million, or 50.0%, from $9.4 million for the six months ended March 31, 2002. Research and development expenses for the six months ended March 31, 2003 were 9.9% of revenues compared to 9.1% for the six months ended March 31, 2002.

CPS. Research and development expenses for the six months ended March 31, 2003 were $9.1 million, an increase of $2.5 million, or 37.9% from $6.6 million for the six months ended March 31, 2002. Research and development expenses for the six months ended March 31, 2003 were 10.4% of revenues compared to 9.3% for the six months ended March 31, 2002. The increase resulted from additional investments in new scanner technology, which investments were primarily devoted to PET/CT and LSO scanner developments.

PETNET. Research and development expenses for the six months ended March 31, 2003 were $2.8 million, an increase of $1.7 million, or 154.5%, from $1.1 million for the six months ended March 31, 2002. Research and development expenses for the six months ended March 31, 2003 were 8.4% of revenues compared to 4.3% of revenues for the six months ended March 31, 2002. The increase was due to increased investment in radiopharmaceutical research and development, which resulted in the addition of personnel and consulting expenses. We expect research and development expenses in our PETNET segment to increase as we pursue the development of new radiopharmaceuticals.

Detector Materials. Research and development expenses for the six months ended March 31, 2003 were $0.5 million, an increase of $0.1 million, or 25.0%, from $0.4 million for the six months ended March 31, 2002. Detector Materials continues to invest in LSO technology to support LSO scanner developments by CPS. Research and development expenses for the six months ended March 31, 2003 were 1.8% of revenues compared to 3.8% for the six months ended March 31, 2002. The relative percentage decrease primarily resulted from the significant increase in revenues.

CTI Services. Research and development expenses for the six months ended March 31, 2003 were $1.7 million, an increase of $0.4 million, or 30.8%, from $1.3 million for the six months ended March 31, 2002. Research and development expenses for the six months ended March 31, 2003 were 3.9% of revenues compared to 6.7% for the six months ended March 31, 2002. The relative percentage decrease primarily resulted from the significant increase in revenues.

Stock-based Compensation Expense

Stock-based compensation expense for the six months ended March 31, 2003 was $0.9 million, a decrease of $7.3 million, or 89.0%, from $8.2 million for the six months ended March 31, 2002, and resulted from the amortization of unearned compensation arising from the pre-IPO issuance of stock options with exercise prices below the fair market value of our common stock on the grant dates. Stock-based compensation expense for the six months ended March 31, 2003 was 0.6% of revenues compared to 8.0% for the six months ended March 31, 2002.

CPS. Stock-based compensation expense for the six months ended March 31, 2003 was $0.2 million, compared to none for the six months ended March 31, 2002. Stock-based compensation expense for the six months ended March 31, 2003 was 0.2% of revenues.

PETNET. Stock-based compensation expense for the six months ended March 31, 2003 was $0.1 million, compared to none for the six months ended March 31, 2002. Stock-based compensation expense for the six months ended March 31, 2003 was 0.3% of revenues.

Detector Materials. No stock-based compensation expense was incurred for the six months ended March 31, 2003 and 2002.

CTI Services. Stock-based compensation expense for the six months ended March 31, 2003 was $0.3 million, compared to none for the six months ended March 31, 2002. Stock-based compensation expense for the six months ended March 31, 2003 was 0.7% of revenues compared to none for the six months ended March 31, 2002.

Corporate and Other. Stock-based compensation expense not charged to other financial reporting segments for the six months ended March 31, 2003 was $0.3 million, a decrease of $7.9 million, or 96.3%, from $8.2 million for the six months ended March 31, 2002.

Income (Loss) from Operations

Income from operations for the six months ended March 31, 2003 was $20.9 million, an increase of $12.4 million, or 145.9%, from $8.5 million for the six months ended March 31, 2002. Income from operations for the six months ended March 31, 2003 was 14.7% of revenues compared to 8.3% for the six months ended March 31, 2002.

CPS. Income from operations for the six months ended March 31, 2003 was $16.6 million, an increase of $0.5 million, or 3.1%, from $16.1 million for the six months ended March 31, 2002. Income from operations for the six months ended March 31, 2003 was 19.0% of revenues compared to 22.6% for the six months ended March 31, 2002. This decrease in operating profit margins results primarily from the increased spending in research and development during the six months ended March 31, 2003.

PETNET. Loss from operations for the six months ended March 31, 2003 was $0.7 million, an increase of $0.4 million, or 133.3%, from a loss of $0.3 million for the six months ended March 31, 2002. Loss from operations for the six months ended March 31, 2003 was 2.1% of revenues, compared to 1.2% of revenues for the six months ended March 31, 2002. The operating loss is primarily the result of increased selling, general and administrative and research and development expenses.

Detector Materials. Income from operations for the six months ended March 31, 2003 was $9.7 million, an increase of $6.7 million, or 223.3%, from $3.0 million for the six months ended March 31, 2002. The increase was primarily the result of growth in intercompany sales of LSO detector materials to CPS in conjunction with the increased shipment volume of LSO based scanners. Income from operations for the six months ended March 31, 2003 was 34.3% of revenues compared to 28.3% for the six months ended March 31, 2002.

CTI Services. Loss from operations for the six months ended March 31, 2003 was $3.7 million, an increase of $2.3 million, or 164.3%, from $1.4 million for the six months ended March 31, 2002. The loss from operations for the six months ended March 31, 2003 was primarily due to investments to expand our business as a direct distributor of PET scanners and the increase of sales and marketing expenses in advance of scanner sales due to established sales cycles. Loss from operations for the six months ended March 31, 2003 was 8.5% of revenues compared to 7.2% for the six months ended March 31, 2002.

Corporate and Other. Loss from operations for the six months ended March 31, 2003 was $1.0 million, a decrease of $7.9 million, or 88.8%, from a loss from operations of $8.9 million for the six months ended March 31, 2002. The decrease in the operating loss was primarily due to the decrease in stock-based compensation expense.

Interest Expense, Net

Interest expense for the six months ended March 31, 2003 was $0.3 million, a decrease of $2.0 million, or 87.0%, from $2.3 million for the six months ended March 31, 2002, resulting from substantial long-term debt repayments and an increase in cash and marketable securities after our initial public offering in June 2002.

Provision for Income Taxes

The income tax provision for the six months ended March 31, 2003 was $8.1 million an increase of $3.5 million, or 76.1%, from $4.6 million for the six months ended March 31, 2002. The effective tax rate for the six month period ended March 31, 2003 was 37.9%. The income tax provision for the six months ended March 31, 2002, was $4.6 million even though there was a pretax loss of $2.3 million. This resulted from charges against income of $17.1 million for stock-based compensation and warranty liability mark to market that are not tax deductible.

Minority Interests

The minority interest expense for the six months ended March 31, 2003 was $5.3 million an increase of $0.4 million, or 8.2% from $4.9 million for the six months ended March 31, 2002. The increase is due to the increase in the net income of CPS.

Liquidity and Capital Resources

In June 2002 we consummated our initial public offering of common stock and we received net proceeds of approximately $171.4 million. Historically, our principal sources of liquidity had been borrowings under our credit facilities, capital leases and the issuance of redeemable preferred stock. Our principal liquidity requirements are to service our debt and meet our working capital and capital expenditure needs.

Our working capital and capital expenditure needs have increased in order to support the growth in our business and due to the seasonality of our revenues. For example, from September 30, 2002 to March 31, 2003, our inventories increased from $69.3 million to $83.6 million and our total accounts receivable increased from $73.7 million to $74.6 million, both due to the seasonal nature of our business. Our property and equipment (net) increased from $77.7 million to $95.6 million.

On September 30, 2002 we entered into an amended and restated credit agreement with a syndicate of banks agented by SunTrust Bank. Our subsidiaries guarantee all obligations under the credit agreement, except that the guarantee of CPS is limited to $55 million and does not include any advances under the credit agreement that are loaned (on an intercompany basis) to our PETNET subsidiary. Our obligations and the obligations of our subsidiary guarantors under the credit agreement 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 obligations of CPS is principally limited to the accounts receivable and inventory of CPS.

The credit agreement makes available to us up to $125 million in revolving loans, with a $10 million sub-limit for letters of credit. Total availability under the credit agreement may be limited from time to time based on the value of certain of our assets and by our earnings before interest, taxes, depreciation, amortization, and minority interest (referred to as EBITDAM). As of March 31, 2003 no balance was outstanding under the credit agreement.

Interest on outstanding borrowings under the credit agreement accrues at LIBOR for the applicable interest period selected by us or, at our option, a variable base rate (based on SunTrust’s prime rate or the federal funds rate), plus in each case a performance-based margin determined by our debt to EBITDAM ratio. The credit agreement contains customary affirmative, negative and financial covenants. For example, we are restricted in incurring additional debt, disposing of assets, making investments, allowing fundamental changes to our business or organization, and making certain payments in respect of stock or other ownership interests, such as dividends and stock repurchases. Financial covenants include requirements that we maintain: a debt to EBITDAM ratio no greater than 3 to 1 through September 30, 2002, and 2.5 to 1 thereafter; a fixed charge coverage ratio no less than 3 to 1; and a minimum tangible net worth of $195.0 million plus 50% of positive net income accrued since the end of the preceding fiscal quarter plus 80% of the net proceeds of any equity offering. The credit agreement also contains customary events of default. These include cross-defaults to other debt agreements, a change in control involving us or any subsidiary guarantor, and the failure to comply with certain covenants.

Historically we have used capital leases to finance PETNET cyclotrons and detector material equipment, and we financed the amounts of $0.4 million and $10.8 million for the six months ended March 31, 2003 and 2002, respectively. In September 2002, PETNET repaid $14.5 million of outstanding capital lease obligations, which had interest rates higher than our current incremental borrowing rate, to reduce our cost of capital.

CTI guarantees lease obligations for radiopharmacy facilities and equipment on behalf of unconsolidated investees in the maximum aggregate amount of $0.9 million at March 31, 2003. No liability has been recorded for these lease obligations which expire through 2009. The guarantees are not collaterized by any assets, and are without recourse.

We anticipate that our current cash and cash equivalents balances and our operating cash flow, together with borrowings under our credit facility, will be sufficient to meet our currently anticipated future operating expenses, capital expenditures and debt service obligations as they come due.

Cash Flows

Six months ended March 31, 2003 compared to six months ended March 31, 2002

Net cash provided by operating activities was $1.4 million and $2.6 million for the six months ended March 31, 2003 and 2002, respectively. The decrease in net cash provided by operating activities was primarily due to an increase in working capital deployed, due to increased sales volume.

Net cash used in investing activities during the six months ended March 31, 2003 and 2002 was $16.1 million and $9.7 million, respectively. In 2003 investing activities consisted primarily of our facility expansion and PETNET radiopharmacy expansion. In 2002 investing activities consisted primarily of increases in detector material equipment and increases in other assets used in the detector material production process.

Net cash provided by financing activities during the six months ended March 31, 2003 was $5.4 million compared to net cash used of $6.9 million for the six months ended March 31, 2002. In 2003, cash provided came from issuances of common stock under the employee stock purchase plan, exercises of stock options, and cash management.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We continuously evaluate our critical accounting policies and estimates, including those related to revenue recognition, valuation of goodwill and accounting for investees. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies require significant judgments and estimates in the preparation of our consolidated financial statements.

Revenue Recognition

We record revenues and related cost of revenues from sales of products and services when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, contract price is fixed or determinable, and collectibility is reasonably assured. We derive our revenues primarily from sales of PET scanners, detector materials and cyclotron systems, distribution of radiopharmaceuticals and provision of services on equipment sold. Revenues derived from sales of scanners and detector materials are recognized upon shipment when all other revenue recognition criteria have been met. Revenues derived from installing scanners and associated training are deferred and recognized when installation and training are complete. All revenues from cyclotron systems sales are recognized upon installation and acceptance. Installation is deemed essential to the functionality of cyclotrons. Significant judgment is involved in determining whether or not installation services are essential to the functionality of the scanning equipment and cyclotrons. The timing of revenue recognition in our financial statements would vary if our determinations of whether installation is deemed essential to functionality were different. Revenues derived from distribution of radiopharmaceuticals are recognized upon delivery of products. Equipment maintenance service contracts are typically three or more years in duration and related revenues are recognized ratably over the respective contract periods as the services are performed.

Valuation of Goodwill

On October 1, 2001, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, which required us to perform an initial impairment review of our goodwill at that date and will require us to perform impairment reviews thereafter, at least once annually. The transitional impairment test requires us to: (1) identify our reporting units; (2) determine the carrying value of each reporting unit by assigning assets and liabilities, including existing goodwill and intangible assets, to those reporting units; and (3) determine the fair value of each reporting unit. We conducted the transitional impairment test and it did not result in any impairment charges. While we will no longer record monthly amortization expense for goodwill, future events and changes in circumstances may require us to record an impairment charge in any given period.

Accounting for Investees

We periodically enter into arrangements in which we hold a majority of the equity ownership. In some instances, we also have influence over a majority of the board of directors or managers. We determine accounting for these investments under SFAS No. 94 and Accounting Principles Board Opinion No. 18 and, where appropriate, evaluate our and the minority shareholder’s participating rights in accordance with Emerging Issues Task Force 96-16 to determine whether consolidation or equity method accounting is appropriate in each case.

We own a majority interest in CPS. Decisions deemed participating rights, including approval of operating budgets and management compensation, are determined by majority board vote. Under the terms of an agreement between Siemens and us, the board of directors of CPS consists of two directors selected by CTI, two directors selected by Siemens and a fifth director selected by Siemens from a list of persons provided by CTI. We believe that this provides us with the ability to control board decisions regarding the daily operations of CPS. Accordingly, CPS is consolidated in our financial statements. If we did not consolidate CPS, our revenues would decrease by $42.9 million (unaudited) and $51.2 million (unaudited) for the six months ended March 31 2003 and 2002, respectively. However, net income would remain unchanged.

PETNET owns 90% and 51.0% interests in radiopharmacies in Denver and Houston, respectively. Under the terms of the Denver and Houston radiopharmacy operating agreements, PETNET has control over all significant operating decisions and these radiopharmacies are consolidated in our financial statements. PETNET accounted for its Houston joint venture under the equity method in the 2002 financial statements in accordance with EITF 96-16. In March 2003, an amendment to the joint venture agreement was adopted, which removed the participating rights of the minority partner. PETNET is now deemed to have control over the significant operating decisions of the joint venture and the entity is now consolidated in the Company’s financial statements effective March 1, 2003.

In cases where the minority stockholder is deemed to have significant “veto rights” or has equal representation on the board, we account for these investments using the equity method, as we do not have control over significant operating decisions. We have invested in four radiopharmacies that are accounted for under the equity method.

Recent Accounting Pronouncements

Asset Retirement

In August 2001 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, which is effective for fiscal years beginning after June 15, 2002. This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Statement of Financial Accounting Standards No. 143 requires, among other things, that the retirement obligations be recognized when they are incurred and displayed as liabilities on the balance sheet. In addition, the asset’s retirement costs are to be capitalized as part of the asset’s carrying amount and subsequently recorded to expense over the asset’s useful life. The adoption of Statement of Financial Accounting Standards No. 143 had no significant impact on our financial statements.

Accounting for Impairment

In October 2001 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. This Statement develops one accounting model for long-lived assets that are to be disposed of by sale, as well as addressing the principal implementation issues. The adoption of Statement of Financial Accounting Standards No. 144 had no significant impact on our financial statements.

Sale-Leaseback Transactions

In April 2002 FASB issued SFAS No. 145, (SFAS 145) Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, which is effective for transactions occurring after May 15, 2002 and fiscal nine months beginning after May 15, 2002. SFAS 145 rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements and amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The adoption of SFAS 145 had no significant impact on our financial statements; however, SFAS 145 will require the Company to reclassify the loss on early extinguishments of debt from extraordinary to other (income) expense in our future comparative financial statements.

Costs Associated with Exit or Disposal Activities

In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 146 (SFAS No. 146) Accounting for Costs Associated with Exit or Disposal Activities, which is effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. SFAS 146 addresses financial accounting and reporting for the costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Costs to Exit and Activity (Including Certain Costs Incurred in a Restructuring). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, and establishes that fair value is the objective for initial measurement of the liability. The adoption of SFAS 146 had no significant impact on the Company’s financial statements.

Accounting for Revenue Arrangements with Multiple Deliverables

In November 2002, the Financial Accounting Standards Board reached a consensus on Emerging Issues Task Force Issue 00-21 (the Issue), Accounting for Revenue Arrangements with Multiple Deliverables. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. This Issue addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, this Issue addresses how to determine whether an arrangement involving multiple deliverables contains more than one earnings process and, if it does, how to divide the arrangement into separate units of accounting consistent with the identified earning processes for revenue recognition purposes. This Issue also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. The Company is evaluating the effect of this Issue on its financial statements.

Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others

On November 25, 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies (FAS 5), relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the entity (i.e., the guarantor) must recognize a liability for the fair value of the obligation it assumes under that guarantee. The Board believes that, in current practice, many entities might not be recognizing that liability, believing that GAAP does not require recognition, particularly when the entity does not receive separately identifiable consideration (i.e., a premium) for issuing the guarantee. Many guarantees are embedded in purchase or sales agreements, service contracts, joint venture agreements, or other commercial agreements and the guarantor in many such arrangements does not receive a separately identifiable upfront payment for issuing the guarantee. FIN 45 is intended to improve the comparability of financial reporting by requiring identical accounting for guarantees issued with a separately identified premium and guarantees issued without a separately identified premium. FIN 45’s provisions for initial recognition and measurement should be applied on a prospective basis to guarantees issued or modified after December 31, 2002, regardless of the guarantor’s fiscal year-end. The guarantor’s previous accounting for guarantees that were issued before the date of FIN 45’s initial application may not be revised or restated to reflect the effect of the recognition and measurement provisions of FIN 45. The Company adopted the disclosure requirements of FIN 45 in the Company’s financial statements. Additional information about guarantees has been disclosed in the notes to the Company’s March 31, 2003 financial statements.

Consolidation of Variable Interest Entities

On January 17, 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. FIN 46 is an effort to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is any legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. The

objective of FIN 46 is to improve financial reporting by companies involved with variable interest entities. Previously, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company is assessing the impact of FIN 46 on its unconsolidated investees and joint ventures, yet does not currently believe any qualify as variable interest entities.

Accounting for Stock-Based Compensation

On December 31, 2002 the FASB issued Statement of Financial Accounting Standard 148 (SFAS 148), Accounting for Stock-Based Compensation – Transition and Disclosure. SFAS 148 amends FASB Statement No. 123 (SFAS 123), Accounting for Stock-Based Compensation, to provide alternative methods of transition to SFAS 123’s fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 28, Interim Financial Reporting, to require the disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. The Statement’s amendments of transition and annual disclosure requirements are effective for fiscal years ending after December 15, 2002, with earlier application permitted for entities with fiscal years ending prior to December 15, 2002. In addition, SFAS 148’s amendment of interim disclosure requirements is effective for interim periods beginning after December 15, 2002. The Company believes that the adoption of SFAS 148 will not have a significant impact on the Company’s financial statements. As now required by SFAS 148 additional information about stock options has been presented in the stock-based compensation accounting policy disclosure in the Company’s March 31, 2003 financial statements.

Factors Affecting Operations and Future Results

We face intense competition, including competition from competitors with greater resources, which may place pressure on our pricing and otherwise make it difficult for us to compete effectively in the molecular imaging market.

The market for molecular imaging equipment and related products and services is intensely competitive and is affected significantly by new product introductions, aggressive pricing strategies of competitors and other marketing activities of industry participants. We compete directly with a number of other companies in the molecular imaging equipment market including GE Medical Systems and Philips Medical Systems. In our radiopharmaceutical business, we compete with for-profit corporations, such as Cardinal Health, Inc. (which acquired Syncor International Corporation) and ION Beam Applications s.a. (and its subsidiary, Eastern Isotopes), as well as regional pharmacies and universities. The intense and increasing level of competition in the market for radiopharmaceuticals and the generic nature of the radiopharmaceuticals currently in production has caused and may continue to cause downward pressure on pricing. Many of our competitors are significantly larger than us and enjoy competitive advantages over us, including:

• significantly greater name recognition;

• better established distribution networks and relationships with health care providers, group purchasing entities and third-party payors;

• additional lines of products and the ability to offer rebates, provide upgrades to previously installed machines or bundle products in order to offer discounts or incentives;

• greater ability to finance capital equipment sales for their customers; and

• greater resources for product development, sales and marketing and patent prosecution and litigation.

Our competitors have developed and will continue to develop new products that compete directly with our products. In addition, our competitors spend significantly greater funds for the research, development, promotion and sale of new and existing products. These resources can allow them to respond more quickly to new or emerging technologies and changes in customer requirements. For the foregoing reasons, we may not be able to compete successfully against our current and future competitors.

If third-party payors do not provide adequate levels of coverage or reimbursement for procedures conducted with our products, health care providers may be reluctant to use and purchase our products.

Sales of some of our products indirectly depend on whether coverage and adequate reimbursement is available for procedures conducted with our products from third-party health care payors, such as Medicare, Medicaid, private insurance plans, health maintenance organizations and preferred provider organizations. The availability of such reimbursement affects our customers’ decisions to purchase capital equipment. Third-party payors are increasingly challenging the pricing of medical procedures or limiting or denying reimbursement for specific services or devices, and we cannot assure you that reimbursement levels will be sufficient to enable us to maintain or increase sales and price levels for our products. Without adequate coverage and reimbursement from third-party payors, the market for our products may be limited.

Medicare reimbursement rates are established by the U.S. Department for Health and Human Services’ Centers for Medicare and Medicaid Services (CMS), the government agency that administers Medicare and Medicaid. From time to time, CMS adjusts the reimbursement rates for medical procedures to reflect the costs incurred by health care providers to perform the procedures. In connection with one of these routine adjustments, which were not specific to our products, CMS recently reviewed and made no change to the reimbursement rate for certain common hospital outpatient PET procedures. In the future, Medicare reimbursement rates for these and other PET applications may be subject to reevaluation by CMS and could be subject to further adjustments.

Today there is no standard reimbursement rate for PET procedures among private third-party payors such as indemnity insurers, health maintenance organizations and preferred provider organizations. In our experience, private payors typically reimburse health care providers for PET procedures at approximately the same rate as Medicare. However, the reimbursement rates offered by private payors are market driven and are therefore subject to market conditions. For example, in markets with significant competition among health care providers, the reimbursement rates can be driven downward due to competitive contracting between third-party payors and health care providers. The reimbursement rates offered by private payors for procedures conducted with our products could be negatively impacted by market conditions or by a decrease in Medicare reimbursement rates.

Moreover, we cannot assure you that additional procedures using our products will qualify for reimbursement from third-party payors in the U.S. or in foreign countries. If additional PET procedures are not approved for reimbursement in a manner consistent with our expectations and assumptions, our business may not grow as much or as fast as we expect it to grow.

If Siemens exercises its option to purchase a majority interest in our subsidiary, CPS, Siemens will acquire a large portion of our revenues, operations and assets.

For the three months and six month periods ended March 31, 2003 and 2002, approximately 63.0% and 73.6%, and 61.3% and 69.3% respectively, of our consolidated revenues were derived from the sale of PET equipment manufactured by our 50.1% owned subsidiary, CPS. Siemens owns the remaining 49.9% of CPS pursuant to a joint venture agreement that we entered into with Siemens in 1987. According to this joint venture agreement, Siemens has an option to acquire from us for cash up to an 80% interest in CPS, if and when CPS achieves specified unit sales volumes. Siemens’ right to exercise this option is contingent upon CPS 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 CPS beginning on December 9, 1987. As of March 31, 2003, the cumulative total number of units sold by CPS under this agreement was 593. By the end of fiscal year 2003 CPS would need to have sold a cumulative total of 981 units to achieve the required cumulative sales level for the option to be exercisable. After 2002 the cumulative unit sales requirement increases by 74 units each year thereafter. It is impossible to state definitively when the option will become exercisable; however, we currently believe that the specified sales volumes are not likely to be met before 2005. Once these sales volumes are achieved, we have the right to defer the exercise of the option for one year. If Siemens exercises its option and increases its ownership

interest in CPS to 80%, Siemens could use that controlling ownership interest to cause CPS to engage in a transaction the effect of which would be a purchase by Siemens of our remaining 20% ownership interest in CPS. Accordingly, the Siemens option effectively gives Siemens the ability to acquire 100% of CPS.

In the event Siemens acquires 100% of CPS, we would continue to have a right to distribute PET and PET/CT products manufactured by CPS until at least 2010 pursuant to the terms of a distribution agreement between us and CPS. The joint venture agreement also contains cross covenants not to compete, which prohibit the parties to the joint venture agreement from participating in or owning an interest in any business engaged in the manufacture, development, or sale of products that compete with the products offered by CPS currently, and for a period of three years following the closing of the exercise of the Siemens’ option.

The exercise of the Siemens option would eliminate a large portion of our revenues, operations and assets, including some valuable employees and intellectual property assets relating to the manufacture and development of PET scanners. As of March 31, 2003, approximately 31.9% of our total assets were attributable to CPS. Accordingly, if we fail to further diversify our business beyond that which is conducted by CPS, or if we fail to deploy effectively the option exercise proceeds received from Siemens, the exercise of the Siemens option could have a material adverse effect on our business. In addition, the existence of the Siemens option, even if not exercised, could negatively impact the market price of our common stock and limit our ability to enter into transactions or business relationships with companies that have competitive PET products. Further, we cannot assure you that the proceeds received upon exercise of the option will adequately compensate us for the loss of control of CPS.

If we cannot develop CTI as a recognized distributor of ECAT® scanners, we will be unable to compete effectively as a distributor of scanners.

Prior to April 2001 all of CPS’ ECAT® scanners were sold with the name Siemens located on the face of the system. As a result, CTI is not recognized widely in the PET industry as a distributor of ECAT® scanners. Pursuant to our distribution agreement with CPS, the CTI name and logo now appears on the face of each ECAT® scanner sold directly by us. During the six months ended March 31, 2003 and 2002, approximately 23.4% and 6.3%, respectively, of the PET scanners sold by CPS were sold by us in our capacity as a direct distributor. If we are unable to quickly develop awareness in the market of the CTI name, brand and logo, our ability to compete as a distributor of scanners will be limited and our revenues, financial condition and future growth will suffer.

Since we use distributors to sell our scanners, our future growth could suffer if our existing distributors do not continue to purchase scanners from us or if we are unable to expand our network of distributors.

Our ability to reach our overall sales goals for scanners is dependent upon the sales and marketing efforts of our existing and future third-party distributors, including Siemens and Hitachi Medical Systems America. For example, for the three months and six month periods ended March 31, 2003, sales through Siemens constituted 45.3% and 43.8%, respectively, of our consolidated revenues. If we fail to sell a large volume of our scanners through distributors, we could experience a decline in overall sales. None of our current scanner distributors is obligated to continue selling, or commit the necessary resources to effectively market and sell, our scanner products. In our role as a direct distributor of our scanner products, we have entered into sub-distribution agreements with third parties to distribute our scanners outside of the U.S. If these sub-distributors fail to successfully distribute scanners outside of the U.S., or if we are unable to expand our direct distribution network, we may be unable to compete effectively in foreign markets.

If we are unable to develop new generations of products and enhancements to existing products, we may be unable to attract or retain customers.

Our success is dependent upon the successful development, introduction and commercialization of new generations of products and enhancements to existing products. Our products are technologically complex and must keep pace with technological change, comply with evolving industry standards and compete effectively with new product introductions of our competitors. Accordingly, many of our products require significant planning, design, development and testing at the technological, product and manufacturing process levels. These activities require significant capital commitments and investments on our part.

Our ability to successfully develop and introduce new products and product enhancements, and the associated costs, are also affected by our ability to:

• properly identify customer needs;

• prove feasibility of new products;

• limit the time required from proof of feasibility to routine production;

• limit the timing and cost of regulatory approvals;

• price our products competitively;

• manufacture and deliver our products in sufficient volumes on time, and accurately predict and control costs associated with manufacturing, installation, warranty and maintenance of the products;

• manage customer acceptance and payment for products;

• limit customer demands for retrofits of both new and old products; and

• anticipate and compete successfully with competitors’ efforts.

We cannot be sure that we will be able to successfully develop, manufacture and phase in new products or product enhancements. Without the successful introduction of new products and product enhancements, we may be unable to attract and retain customers and our revenue and operating results will suffer. In addition, even if customers accept new products or product enhancements, the revenues from such products may not be sufficient to offset the significant costs associated with making such products available to customers. Also, announcements of new products or product enhancements may cause customers to delay or cancel their purchasing decisions in anticipation of such products.

If we fail to protect our intellectual property rights, our competitors may take advantage of our ideas and compete directly against us.

We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, nondisclosure and confidentiality agreements, and other contractual restrictions to protect our proprietary technology and other intellectual property rights. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage based on our intellectual property. For example, our patents may be challenged, invalidated or circumvented by third parties. As of March 31, 2003 we have 28 issued U.S. patents and 18 patent applications pending before the U.S. Patent and Trademark Office. We also have patents issued and pending in Europe, Canada and Japan. We have no assurance that our patent applications will result in issued patents or that they will be issued in a form that will be advantageous to us. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by employees. Furthermore, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the U.S. Litigation may be necessary to enforce our intellectual property rights, which could result in substantial costs to us and substantial diversion of management attention. If our intellectual property is not adequately protected, our competitors could use our intellectual property to enhance their products. This could harm our competitive position, decrease our market share or otherwise harm our business.

The prosecution and enforcement of copyrights and patents relating to software and other technology licensed or sold to us by third parties is not within our control, and without this software and technology, we may be unable to manufacture our products or maintain our technological advantage. For example, we license Siemens’ syngo™ software which is an important component of our PET/CT systems. Also, we license the exclusive right to use lutetium oxyorthosilicate, or LSO, technology from the owner of the LSO patent until such time as the LSO patent expires in October 2008. If the third-party suppliers of this software and technology fail to protect their patents or copyrights or if this technology and software is found to infringe on the rights of another party, the functionality of our products could suffer and our ability to bring new and existing products to market could be delayed. In the case of LSO, the expiration of, or the failure to protect, the LSO patent could result in our competitors gaining access to

the LSO technology for use in their molecular imaging products, thereby eliminating one of our important competitive advantages.

Currently, 16 of our issued patents are held in the name of CPS. If Siemens exercises its right to purchase a majority interest in CPS, there is no guarantee that we will have the right to license or otherwise use the technology underlying these patents or other intellectual property that is proprietary to CPS such as manufacturing know-how. Our inability to access or use this technology could harm our business and financial condition.

Our operating results would suffer if we were subject to a protracted infringement claim or a significant damage award.

Substantial intellectual property litigation and threats of litigation exist in our industry. We expect that molecular imaging products may become increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products increases. Educational institutions or other medical device companies may claim that we infringe their intellectual property rights. Any claims, with or without merit, could have the following negative consequences:

• costly litigation and damage awards;

• diversion of management attention and resources;

• product shipment delays or suspensions; and

• the need to enter into royalty or licensing agreements, which may not be available on terms acceptable to us, if at all.

A successful claim of infringement against us could result in a substantial damage award, and could materially harm our financial condition. Our failure or inability to license the infringed or similar technology could prevent us from selling our products and adversely affect our business and financial results.

If we fail to obtain or maintain necessary FDA clearances for our medical device products or similar clearances in non-U.S. markets, or if such clearances are delayed, we will be unable to commercially distribute and market our products.

Our products are medical devices that are subject to extensive regulation in the U.S. and in foreign countries where we do business. Unless an exemption applies, each medical device that we wish to market in the U.S. must first receive clearance from the U.S. Food and Drug Administration (FDA), which is referred to as 510(k) clearance, which can be a lengthy and expensive process. The FDA’s 510(k) clearance process for our devices usually takes four to twelve months from the date the application is submitted, but may take longer. Although we have obtained 510(k) clearance for our current products, our 510(k) clearance can be revoked if safety or effectiveness problems develop. We expect that our products currently under development will require 510(k) clearance. We may not be able to obtain additional clearances in a timely fashion, or at all. Delays in obtaining clearance or the revocation of existing clearances could adversely affect our revenues and profitability.

In addition to clearance requirements, our medical device products are subject to other rigorous FDA regulatory requirements, including Quality System Regulation requirements, labeling and promotional requirements and medical device adverse event reporting requirements. Our failure to satisfy these requirements could result in, among other things, warning letters, fines, injunctions, civil penalties, repairs, replacements, refunds, recalls or seizures of products, total or partial suspension of production, the FDA’s refusal to grant future clearances, withdrawals or suspensions of current product applications, and criminal prosecution. Any of these actions could have a material adverse effect on our business, financial condition, and results of operations.

In many foreign countries in which we market our products, we are subject to regulations affecting, among other things, product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. Many of these regulations are similar to those of the FDA. In addition, in many countries the national health or social security organizations require our products to be qualified before procedures performed using our products become eligible for reimbursement. Failure to receive, or delays in the receipt of, relevant foreign qualifications could have a material adverse effect on our business, financial condition and results

of operations. Due to the movement towards harmonization of standards in the European Union, we expect a changing regulatory environment in Europe characterized by a shift from a country-by-country regulatory system to a European Union-wide single regulatory system. The timing of this harmonization and its effect on us cannot currently be predicted. Adapting our business to changing regulatory systems could have a material adverse effect on our business, financial condition and results of operations.

The FDA and similar governmental authorities in other countries have the authority to require the recall or related remedies of our products in the event of material deficiencies or defects in design or manufacture. A government-mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design defects. Any recall of product would divert management and financial resources and harm our reputation with customers.

Any modification to an FDA-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new FDA 510(k) clearance. The FDA requires every manufacturer to make this determination, but the FDA can review any such decision. We may make additional modifications to our products after they have received clearance, and in appropriate circumstances, determine that new clearance is unnecessary. The FDA may not agree with our decision not to seek new clearance. If the FDA requires that we seek 510(k) clearance for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance. Also, in some circumstances, such as the FDA’s disagreement with our decision not to seek new clearance, we may be subject to significant regulatory fines or penalties.

Proposed FDA regulations could impact our radiopharmaceutical development and manufacturing procedures in the future.

Our PET radiopharmaceuticals currently are manufactured and sold through our PETNET radiopharmacies, each of which operates under an applicable state pharmacy license and compounds these products in response to the order of a licensed physician. The FDA traditionally has deferred regulation of the compounding of PET radiopharmaceuticals in response to the order of a licensed physician to state and local authorities responsible for regulating the practices of medicine and pharmacy. The FDA in the past generally has not subjected such compounded PET products to new drug approval procedures and current good manufacturing practice requirements.

The Food and Drug Administration Modernization Act of 1997 (the “1997 Act”), however, amended the Federal Food, Drug, and Cosmetic Act to provide a new framework for FDA regulation of PET products. The 1997 Act states that FDA can require new drug applications (NDAs) or abbreviated new drug applications (ANDAs) and adherence to current good manufacturing practice requirements for PET products (under the Federal Food, Drug and Cosmetic Act) two years after the agency finalizes appropriate new approval procedures and current good manufacturing practice requirements. FDA has issued a guidance document for the chemistry portion of NDAs and ANDAs for PET products, including F-18-fluorodeoxyglucose, or FDG, the product principally produced and distributed by our PETNET radiopharmacies. Because the 1997 Act prohibits FDA from requiring NDAs or ANDAs for PET products until two years after the agency finalizes appropriate approval procedures and current good manufacturing practice requirements for PET products, the submissions and FDA approval of such applications before these time periods expire is voluntary. FDA has not yet addressed the procedures for approval of other PET products and of new indications for existing PET products. FDA has said, however, that it expects the standards for determining the safety and effectiveness set forth in recently developed FDA regulations for in vivo diagnostic radiopharmaceuticals may apply to PET

Under the 1997 Act, FDA cannot require NDAs or ANDAs for any PET products that comply with the PET compounding standards and the official monographs of the United States Pharmacopoeia until two years after the issuance of final current good manufacturing practice regulations and appropriate procedures for the approval of the specific PET drug product, whichever occurs later. In March 2002, the FDA issued preliminary draft proposed regulations for the current good manufacturing practice requirements. The public comment period for the draft regulations closed on June 5, 2002, after which FDA has said it intends to issue a proposed rule with an additional period for public comment before issuing the final current good manufacturing practice regulations for PET. It is not possible to predict when FDA will finalize these regulations, but we expect that this will take place before the end of calendar year 2003. If so, FDA authority and the proposed approval procedures and current good manufacturing practice requirements would not take effect until sometime near the end of calendar year 2005.

Once the requirements take effect, we could incur significant costs and spend considerable time obtaining FDA approval for existing and newly developed radiopharmaceuticals or for new indications for existing radiopharmaceuticals. Such additional costs and time spent to obtain any required FDA approval could have a material adverse effect on our business, financial condition, and results of operations. With regard to FDA’s proposed current good manufacturing practice requirements for PET drug products, we cannot predict with certainty the precise effects that these requirements might have on our business, financial condition, and results of operations.

Our scanners, cyclotrons and radiopharmaceutical business require the use of radioactive materials which subjects us to regulation, related costs and delays and potential liabilities for injuries or violations of laws related to radioactive materials.

Our scanners, cyclotrons and radiopharmaceutical business require the use of radioactive materials. The storage, use, and disposal of these materials presents the risk of accidental environmental contamination and physical injury. We are subject to federal, state and local regulations governing storage, handling and disposal of these materials and waste products. Outside of the U.S. we are also subject to radiation regulations that vary from country to country and sometimes vary within a given country. Although we believe that our safety procedures for storing, handling and disposing of these hazardous materials comply in all material respects with the standards prescribed by law and regulation, we cannot completely eliminate the risk of accidental contamination or injury from those hazardous materials. Although we currently maintain insurance coverage for these risks, in the event of an accident, we could be held liable for any damages that exceed the limits or fall outside the coverage of our insurance. We may not be able to continue maintaining insurance against these risks on acceptable terms, or at all. We could incur significant costs and diversion of management attention in order to comply with current or future regulations governing radioactive material.

Product liability suits against us could result in expensive and time-consuming litigation, payment of substantial damages, increases in our insurance rates and decreased market acceptance of our products.

The sale and use of our products could lead to the filing of product liability claims if someone were to allege injury from the use of one of our devices or radiopharmaceuticals or allege that one of our devices or radiopharmaceuticals failed to detect a targeted disorder. A product liability claim could result in substantial damages and be costly and time-consuming to defend. We cannot assure you that our product liability insurance will be sufficient to protect us from the financial impact of defending a product liability claim. Any product liability claim brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing insurance coverage in the future. Product liability claims could also adversely affect the marketability of our products and our reputation.

If we are unable to provide the significant education and training required for the health care market to accept our products, our business will suffer.

In order to achieve market acceptance for our products, we are often required to educate physicians about the use of a new procedure and convince health care payors that the benefits of the product outweigh its costs. The timing of our competitors’ introduction of products and the market acceptance of their products may also make this process more difficult. We cannot be sure that any future products we develop will gain any significant market acceptance among physicians, patients and health care payors.

We expect to incur substantial expenses in the future to develop new technology and to expand our business and, as a result, we may not be able to generate sufficient revenues to maintain profitability.

We are currently in the early stages of incorporating the new LSO detector material technology into our PET and PET/CT scanners manufactured by CPS. We will incur significant expenses over the next several years in order to further develop this new LSO detector material technology. In addition, we anticipate that our expenses will also increase substantially in the foreseeable future as we:

• continue to invest in research and development to enhance our products and develop new technologies;

• develop additional applications for our current technology;

• increase our marketing and selling activities;

• continue to increase the size and number of locations of our customer support organization, including international expansion;

• continue to expand our network of PETNET radiopharmacies in the U.S. and internationally;

• develop additional manufacturing capabilities and infrastructure; and

• hire additional management and other personnel to keep pace with our growth.

As a result of these increased expenses, we will need to generate significantly higher revenues to maintain profitability. We cannot be certain that we will maintain profitability in the future. If we do not maintain profitability, the market price of our common stock may decline substantially.

Our quarterly operating results may fluctuate, which could cause our stock price to decline.

Our revenues and operating results have varied from quarter to quarter in the past and may continue to fluctuate in the future. The following are among the factors that could cause our operating results to fluctuate significantly from quarter to quarter:

• the budget cycles of our customers;

• the size and timing of specific sales and any collection delays or defaults related to those sales;

• changes in the relative contribution to our revenue from our various products;

• the seasonality of capital equipment sales, with the fourth fiscal quarter traditionally being the highest;

• product and price competition;

• the timing, market acceptance and development costs of new product introductions and product enhancements by us or our competitors;

• the length of our sales cycle;

• the timing of hiring and the timing of incentive compensation for our sales and marketing personnel;

• a downturn in general economic conditions; and

• the loss of key sales personnel or distributors.

Many of these factors are beyond our control, and you should not rely on our results of operations for prior periods as an indication of our expected results in any future period. If our revenues vary significantly from quarter to quarter, our business could be difficult to manage and our quarterly results could fall below expectations of investors and stock market analysts, which could cause our stock price to decline.

We are subject to risks associated with international operations.

We conduct business globally. International sales accounted for approximately 33.1% and 36.6%, and 25.5% and 27.2%, respectively, of sales in the three months and six months periods ended March 31, 2003 and 2002, respectively. Our sales in the U.S. have grown rapidly as a result of a significant expansion in the U.S. market for PET products and services and our expanded product line. We also acquire various raw materials and components from international suppliers. We intend to expand our presence in international markets, and we cannot assure you that we will compete successfully in international markets or meet the service and support needs of foreign customers. Our future results could be harmed by a variety of factors, including:

• difficulties in enforcing agreements and collecting receivables through the legal systems of foreign countries;

• the longer payment cycles associated with many foreign customers;

• the possibility that foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade;

• fluctuations in exchange rates, which may affect product demand and adversely affect the profitability in U.S. dollars of products and services provided by us in foreign markets where payment is made in local currency;

• our ability to obtain U.S. export licenses and other required export or import licenses or approvals;

• changes in the political, regulatory or economic conditions in a country or region; and

• difficulty protecting our intellectual property in foreign countries.

Our production and manufacturing capabilities may not be sufficient to meet the expected future demand for our products and services.

If we are unable to increase our production and manufacturing capabilities, we may be unable to meet the expected future demand for our products. In order to produce a sufficient supply of products using our technology, we must improve and expand our current manufacturing facilities and processes. We may experience quality problems, substantial costs and unexpected delays in our efforts to upgrade and expand our manufacturing capabilities. If we fail to obtain the necessary capital to expand our manufacturing facilities or if we incur delays due to quality problems or other unexpected events, we will be unable to produce a sufficient supply of products necessary to meet our future growth expectations.

If we lose or experience a deterioration in our relationship with any supplier of key product components, or if key components are otherwise not available in sufficient quantities, our manufacturing could be delayed.

We contract with third parties for the supply of some of the components and materials used in our products. For example, we obtain a significant portion of the raw materials needed to manufacture our LSO detector material from a single source. Isotopically enriched water, which is necessary for the development of our radiopharmaceuticals, is only available from a limited number of sources. Further, to supplement our own crystal production operations, a single supplier manufactures a substantial amount of our LSO detector requirements. Some of our suppliers are not obligated to continue to supply us. For some of these materials and components, relatively few alternative sources of supply exist. In addition, the lead-time involved in the manufacturing of some of these components can be lengthy. If these suppliers become unwilling or unable to supply us with our requirements, it may be difficult to establish additional or replacement suppliers in a timely manner, if at all. This would cause our product sales to be disrupted and our revenues and operating results to suffer.

Replacement or alternative sources might not be readily obtainable due to regulatory requirements and other complexities of our manufacturing operations and requirements. Incorporation of components from a new supplier into our products may require a new or supplemental filing with applicable regulatory authorities and clearance or approval of the filing before we could resume product sales. This process may take a substantial period of time, and we may be unable to obtain the necessary regulatory clearance or approval. This could also create supply disruptions that would harm our product sales and operating results.

If we fail to comply with health care regulations, we could face substantial penalties and our business, operations and financial condition could be adversely impacted.

While we do not deliver health care services directly to patients, control referrals of health care services or bill directly to Medicare, Medicaid or other third-party payors, due to the breadth of many health care laws and regulations, we cannot assure you that they will not apply to our business. We could be subject to health care fraud and patient privacy regulation by both the federal government and the states in which we conduct our business. The regulations that may affect our ability to operate include:

• the federal Medicare and Medicaid Anti-Kickback Law, which prohibits among other things persons from soliciting, receiving or providing remuneration, directly or indirectly, to induce either the referral of an individual, for an item or service or the purchasing or ordering of a good or service, for which payment may be made under federal health care programs such as the Medicare and Medicaid programs;

• federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers;

• the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which prohibits executing a scheme to defraud any health care benefit program or making false statements relating to health care matters and which also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information; and

• state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor (including commercial insurers), and state laws governing the privacy of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA (thus complicating compliance efforts).

If our operations are found to be in violation of any of the laws described above or any of the other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Moreover, to achieve compliance with applicable federal and state privacy, security, and electronic transaction laws, we may be required to modify our operations with respect to the handling of patient information. Implementing these modifications may prove costly and time consuming. At this time, we are not able to determine the full consequences to us, including the total cost of compliance, of these various federal and state laws.

The application of state certificate of need regulations and compliance with federal and state licensing requirements could substantially limit our ability to sell our products and grow our business.

Some states require health care providers to obtain a certificate of need or similar regulatory approval prior to the acquisition of high-cost capital items including molecular imaging systems like ours or the provision of diagnostic imaging services. In many cases, a limited number of these certificates are available. As a result of this limited availability, hospitals and other health care providers have at times been unable to obtain a certificate of need and purchase our PET scanners. Further, our sales cycle for PET scanners is typically longer in certificate of need states

due to the time it takes our customers to obtain the required approvals. Accordingly, certificates of need or similar requirements could limit our ability to market our products and adversely impact our revenues and results of operations. Also, our ability to grow our radiopharmaceutical distribution network is contingent on our or our customers’ ability to obtain the necessary licenses and registrations for each new facility, which may include a radioactive materials license, pharmacy license, and cyclotron registration. If we or our customers fail to obtain such licenses and registrations or if substantial delays are incurred in obtaining such licenses and registrations, we may be unable to expand this business and our sales growth will be negatively impacted. Further, the pharmacists operating in our PETNET radiopharmacies must be licensed and many states require imaging technologists that operate PET systems to be licensed or certified. Any lapse in our licenses, or the licenses of our pharmacists or technologists, could increase our costs and adversely affect our operations and financial results. In addition, our customers must meet various federal and state regulatory and/or accreditation requirements in order to receive payments from the government-sponsored health care programs such as Medicare and Medicaid. Any lapse by our customers in maintaining appropriate licensure, certification or accreditation or the failure of our customers to satisfy the other necessary requirements under government-sponsored health care programs could cause our sales to decline.

Our business strategy emphasizes growth, which places significant demands on our financial, operational and management resources and creates the risk of failing to meet the growth expectations of investors.

Our growth strategy includes efforts to develop new products, services and technologies as well as new distribution channels. The pursuit of this growth strategy consumes capital resources, thereby creating the financial risk that we will not realize an adequate return on this investment. In addition, our growth may involve the acquisition of companies, the development of products or services or the creation of strategic alliances in areas in which we do not currently operate. This would require our management to develop expertise in new areas, manage new business relationships and attract new types of customers. The success of our growth strategy also depends on our ability to expand our financial, operational and management resources and to attract, train, motivate and manage an increasing number of employees. The success or failure of our growth strategy is difficult to predict. The failure to achieve our stated growth objectives or the growth expectations of investors could disappoint investors and harm our stock price. We may not be able to implement our growth strategy successfully or manage our expanded operations effectively and profitably.

Our costs could substantially increase if we receive a significant number of warranty claims.

We generally warrant each of our products against defects in materials and workmanship for a period of twelve months from the acceptance of our product by a customer or eighteen months from the date of shipment to a distributor. Further, we have entered into long-term service agreements with certain customers pursuant to whom we have agreed to provide all necessary maintenance and services for a fixed fee. If we experience an increase in product returns or warranty claims, we could incur unanticipated additional expenditures for parts and service. In addition, our reputation and goodwill in the PET market could be damaged. While we have established reserves for liability associated with product warranties, unforeseen warranty exposure in excess of those reserves could adversely affect our operating results.

Our executive officers and directors and their affiliates hold a substantial portion of our stock and could exercise significant influence over matters requiring stockholder approval, regardless of the wishes of other stockholders.

Our executive officers, principal stockholders and directors and entities affiliated with them beneficially own, in the aggregate, approximately 45.9% of our common stock as of March 31, 2003. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. These stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring, or preventing a change in control, or impeding a merger or consolidation, takeover, or other business combination that could be favorable to our investors.

Certain provisions of our charter, bylaws and Delaware law may delay or prevent a change in control of our company.

Our corporate documents and Delaware law contain provisions that may enable our board of directors to resist a change in control of our company. These provisions include: (a) a staggered board of directors; (b) limitations on persons authorized to call a special meeting of stockholders; (c) the authorization of undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; (d) advance notice procedures required for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; and (e) a stockholder protection rights agreement or “poison pill.”

These anti-takeover defenses could discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and cause us to take other corporate actions you desire.

Our stock price may be volatile.

We consummated the initial public offering of our common stock on June 21, 2002. Accordingly, there has only been a public market for shares of our common stock for a limited period of time. An active public trading market may not develop or, if developed, may not be sustained. Further, we expect that the market price of our common stock may fluctuate substantially. The market price for the common stock may be affected by a number of factors, including: (a) volume and timing of orders for our products; (b) our ability to develop, obtain regulatory clearance for, and market, new and enhanced products on a timely basis; (c) the announcement of new products or product enhancements by us or our competitors; (d) announcements of technological or medical innovations in the monitoring or treatment of diabetes; (e) product liability claims or other litigation; (f) quarterly variations in our or our competitors’ results of operations; (g) changes in governmental regulations or in the status of our regulatory approvals or applications; (h) changes in the availability of third-party reimbursement in the United States or other countries; (i) changes in earnings estimates or recommendations by securities analysts; and (j) general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.

The sales of a substantial number of shares of our common stock may adversely affect the market price for our common stock.

Our initial public offering in June 2002 created a public market for our common stock for the first time in our company’s history. Many of our stockholders who acquired shares before our initial public offering now have the opportunity to sell such shares in the public market. Many of these stockholders have held their shares for a long time and may desire to sell some or all of their shares in the near future. Sales of a substantial number of shares of our common stock in the public market or the market perception that these sales may occur, could significantly and negatively affect the market price for our common stock.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

Our exposure to market risk relates to changes in interest rates for borrowings under our revolving credit facility, our industrial revenue bonds, mortgage loan and a building construction loan. These borrowings bear interest at variable rates. Based on our outstanding borrowings during the period ended March 31, 2003, a hypothetical 1.0% increase in interest rates would have increased our interest expense by less than $0.1 million and would have decreased our cash flow for the quarter from operations by less than $0.1 million.

The Company’s cash equivalents and short-term investments are subject to market risk, primarily interest-rate and credit risk. The Company’s investments are managed by outside professional managers within investment guidelines set by the Company. Such guidelines include security type, credit quality, and maturity and are intended to limit market risk by restricting the Company’s investments to high credit quality securities with relatively short-term maturities.

As of March 31, 2003 we had cash and cash equivalents of $75.9 million which consisted of highly liquid money market instruments with maturities less than 90 days, and $3.6 million of marketable securities with maturities greater than 90 days. Because of the short maturities of these instruments, a sudden change in market interest rates would not have a material impact on the fair value of the portfolio. We would not expect our operating results or cash flows to be materially affected by the effect of a sudden change in market interest rates on our portfolio.

Foreign Currency Exchange Risk

International revenues from the Company’s foreign direct sales and distributor sales comprised 33.1% and 25.5%, respectively, of total revenues for the three months and six month periods ended March 31, 2003. The Company experienced an immaterial amount of transaction gains and losses for the three months ended March 31, 2003. The Company is also exposed to foreign exchange rate fluctuations as the financial results of its German subsidiary are translated into U.S. dollars in consolidation. As exchange rates vary, these results when translated may vary from expectations and adversely impact overall expected profitability. The net effect of foreign exchange rate fluctuations on the Company during the six months ended March 31, 2003 was not material.

Equity Security Price Risk

We do not have any investments in marketable equity securities. Therefore, we do not currently have any direct equity price risk.

ITEM 4. Controls and Procedures

Within 90 days prior to the filing of this report, the Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures. As of the date that evaluation was completed (Evaluation Date), the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company maintains disclosure controls and procedures that provide reasonable assurance that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date, including any corrective actions with regard to significant deficiencies and material weaknesses.

Part II: Other Information

ITEM 1. Legal Proceedings

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. Because our investigation with respect to the allegations is at a preliminary stage, an estimate of the possible loss or range of loss, if any, cannot be made. Nevertheless, we deny liability and intend to vigorously defend this suit.

On September 19, 2002, General Electric filed a complaint against two former employees of General Electric who 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, and have denied liability.

ITEM 2. Changes in Securities and Use of Proceeds

a) Modification of Constituent Instruments: None

b) Modification of Stockholder’s Rights: None

c) Sales of Unregistered Securities: None

d) Use of Proceeds: The Registration Statement on Form S-1 (SEC 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 $16,043, was approximately $171,387. As of March 31, 2003, $10,215 of the net offering proceeds had been used to redeem all of our Series A Redeemable Preferred Stock, including all accrued dividends, $343 of the net offering proceeds had been used to redeem 1,191,165 shares of our common stock, and approximately $62,000 of the net offering proceeds had been used to decrease our outstanding balance under our credit facility and approximately $14,503 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.

ITEM 3. Defaults Upon Senior Securities

None

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

CTI’s annual meeting of stockholders (the “Annual Meeting”) was held on March 18, 2003. At the Annual Meeting, CTI’s stockholders of record on January 24, 2003 were asked to take action to (a) elect two Class I directors, Terry D. Douglass, Ph.D., and William W. McInnes, each to serve on the Board of Directors until the Company’s annual meeting of stockholders in 2006 or until their successors have been duly elected and qualified (“Proposal One”), and (b) ratify the reappointment of PricewaterhouseCoopers LLP as CTI’s independent public accountants (“Proposal Two”).

A total of 35,484,823 shares, or approximately 77.6% of the CTI’s outstanding 45,756,891 shares of Common Stock entitled to vote at the Annual Meeting as of the record date, were present in person or by proxy at the Annual Meeting.

With respect to Proposal One, a plurality of the votes cast in favor of each nominee was required for the nominees’ election as Class I director. Both Dr. Douglass and Mr. McInnes received the required plurality of the votes, and each was elected as a director. With respect to Proposal Two, a majority of the shares present and entitled to vote was necessary for the passage of such proposal, and Proposal Two was approved by such a majority.

The breakdown of the votes cast by the stockholders at the Annual Meeting was as follows:


			WITHHELD/
	FOR		AGAINST		ABSTAIN

Proposal One:
(i) Dr. Douglass		31,170,851		4,313,972		N/A
(ii) Mr. McInnes		35,111,828		373,995		N/A
Proposal Two:		35,256,398		93,130		135,295

ITEM 5. Other Information

On February 17, 2003, the Company announced that Mark S. Rhoads had resigned as President of PETNET to pursue outside interests, and Mr. Rhoads was succeeded in such capacity by Thomas J. Hook.

ITEM 6. Exhibits and Reports on Form 8-K


(a)	Exhibits

	Exhibit 99.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	Exhibit 99.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)	Reports on Form 8-K

	During the period covered by this Quarterly Report on Form 10-Q, the Company filed one (1) Current Report on Form 8-K dated February 5, 2003 and filed with the SEC on February 6, 2003, reporting the issuance of a press release reporting the Company’s first quarter 2003 operating results (no financial information required).

SIGNATURE

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


		CTI Molecular Imaging, Inc.

		/s/ David N. Gill David N. Gill Chief Financial Officer and Senior Vice President (Principal Accounting Officer)

		May 14, 2003

CERTIFICATIONS

I, Terry D. Douglass, certify that:

1. I have reviewed this quarterly report on Form 10-Q of CTI Molecular Imaging, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 14, 2003


		/s/ Terry D. Douglass Terry D. Douglass, Ph.D. President and Chief Executive Officer

CERTIFICATIONS

(b) CFO Certification

I, David N. Gill, certify that:

Date: May 14, 2003


		/s/ David N. Gill David N. Gill Chief Financial Officer and Senior Vice President

EXHIBIT INDEX


Exhibit 99.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 99.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	•		our expectations regarding financial condition or results of operations for periods after March 31, 2003;

	•		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 CPS 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;

	•		our ability to develop new proprietary radiopharmaceuticals;

	•		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.

⁽¹⁾		Weighted average contractual life remaining in years.

⁽²⁾		Weighted average exercise price.

	•		significantly greater name recognition;

	•		better established distribution networks and relationships with health care providers, group purchasing entities and third-party payors;

	•		additional lines of products and the ability to offer rebates, provide upgrades to previously installed machines or bundle products in order to offer discounts or incentives;

	•		greater ability to finance capital equipment sales for their customers; and

	•		greater resources for product development, sales and marketing and patent prosecution and litigation.

	•		properly identify customer needs;

	•		prove feasibility of new products;

	•		limit the time required from proof of feasibility to routine production;

	•		limit the timing and cost of regulatory approvals;

	•		price our products competitively;

	•		manufacture and deliver our products in sufficient volumes on time, and accurately predict and control costs associated with manufacturing, installation, warranty and maintenance of the products;

	•		manage customer acceptance and payment for products;

	•		limit customer demands for retrofits of both new and old products; and

	•		anticipate and compete successfully with competitors’ efforts.

	•		costly litigation and damage awards;

	•		diversion of management attention and resources;

	•		product shipment delays or suspensions; and

	•		the need to enter into royalty or licensing agreements, which may not be available on terms acceptable to us, if at all.

	•		continue to invest in research and development to enhance our products and develop new technologies;

	•		develop additional applications for our current technology;

	•		increase our marketing and selling activities;

	•		continue to increase the size and number of locations of our customer support organization, including international expansion;

	•		continue to expand our network of PETNET radiopharmacies in the U.S. and internationally;

	•		develop additional manufacturing capabilities and infrastructure; and

	•		hire additional management and other personnel to keep pace with our growth.

	•		the budget cycles of our customers;

	•		the size and timing of specific sales and any collection delays or defaults related to those sales;

	•		changes in the relative contribution to our revenue from our various products;

	•		the seasonality of capital equipment sales, with the fourth fiscal quarter traditionally being the highest;

	•		product and price competition;

	•		the timing, market acceptance and development costs of new product introductions and product enhancements by us or our competitors;

	•		the length of our sales cycle;

	•		the timing of hiring and the timing of incentive compensation for our sales and marketing personnel;

	•		a downturn in general economic conditions; and

	•		the loss of key sales personnel or distributors.

	•		difficulties in enforcing agreements and collecting receivables through the legal systems of foreign countries;

	•		the longer payment cycles associated with many foreign customers;

	•		the possibility that foreign countries may impose additional withholding taxes or otherwise tax our foreign income, impose tariffs or adopt other restrictions on foreign trade;

	•		fluctuations in exchange rates, which may affect product demand and adversely affect the profitability in U.S. dollars of products and services provided by us in foreign markets where payment is made in local currency;

	•		our ability to obtain U.S. export licenses and other required export or import licenses or approvals;

	•		changes in the political, regulatory or economic conditions in a country or region; and

	•		difficulty protecting our intellectual property in foreign countries.

	•		the federal Medicare and Medicaid Anti-Kickback Law, which prohibits among other things persons from soliciting, receiving or providing remuneration, directly or indirectly, to induce either the referral of an individual, for an item or service or the purchasing or ordering of a good or service, for which payment may be made under federal health care programs such as the Medicare and Medicaid programs;

	•		federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers;

	•		the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which prohibits executing a scheme to defraud any health care benefit program or making false statements relating to health care matters and which also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information; and

	•		state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor (including commercial insurers), and state laws governing the privacy of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA (thus complicating compliance efforts).

	a)		Modification of Constituent Instruments: None

	b)		Modification of Stockholder’s Rights: None

	c)		Sales of Unregistered Securities: None

	d)		Use of Proceeds: The Registration Statement on Form S-1 (SEC 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 $16,043, was approximately $171,387. As of March 31, 2003, $10,215 of the net offering proceeds had been used to redeem all of our Series A Redeemable Preferred Stock, including all accrued dividends, $343 of the net offering proceeds had been used to redeem 1,191,165 shares of our common stock, and approximately $62,000 of the net offering proceeds had been used to decrease our outstanding balance under our credit facility and approximately $14,503 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.

1.		I have reviewed this quarterly report on Form 10-Q of CTI Molecular Imaging, Inc.;

2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.		The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

	a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and