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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Commission File Number: 000-49867

CTI Molecular Imaging, Inc.

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

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

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

Common Stock, $0.01 par value

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

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.     þ

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

      The aggregate market value of common stock held by non-affiliates of the registrant was $468,191,923 as of March 31, 2003, based upon the last sale price of such stock as reported on the Nasdaq National Market on that day (assuming for purposes of this calculation, without conceding, that all executive officers and directors are affiliates).

      There were 45,164,233 shares of common stock outstanding at December 1, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

      Parts of the registrant’s proxy statement for its 2004 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.

Table of Contents

CTI MOLECULAR IMAGING, INC.

TABLE OF CONTENTS

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CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

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

	•	our expectations regarding financial condition or results of operations for periods after September 30, 2003;
	•	our critical accounting policies;
	•	the timing of the exercisability of the Siemens option to purchase an additional ownership interest in CTI PET Systems and the effect of the Siemens option, or its exercise, on our business;
	•	our expectations regarding the size and growth of the market for our products and services and the market acceptance of CTI’s products and services;
	•	our business strategies and our ability to grow our business;
	•	competition, pricing, the seasonality of capital equipment sales, the timing of orders from and shipments to distribution partners and customers, and the availability of financing services for customers;
	•	our ability to enhance existing, or develop new, products and services and the impact of any such enhancements or developments;
	•	the development and timing of new applications for PET and the impact of any such new applications;
	•	the implementation or interpretation of current or future regulations and legislation;
	•	the number and scope of procedures involving our products and services for which third-party reimbursement is available, and the reimbursement levels of third-party payors;
	•	our ability to maintain contracts and relationships with key suppliers, customers, distributors or research and development collaboration partners;
	•	our ability to maintain our existing, or to develop additional, valuable intellectual property rights; and
	•	our future sources of and needs for liquidity and capital resources.

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

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

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

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

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PART I

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

Overview

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

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

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

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

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

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Industry Background

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

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

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

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

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      The most common medical imaging technologies in the U.S. today are X-ray, CT and MRI. These imaging technologies have several advantages over PET, namely they represent the current standard of patient care, provide clear anatomical images, generally are reimbursed, are fast (in the case of X-ray and CT) and today’s radiologists are very competent in reading these types of images. In comparison to CT and MRI, PET has some disadvantages including the lack of exact anatomical images to help pinpoint the location of disease, the poor sensitivity of FDG in certain cancers such as prostate cancer, the lack of reimbursement for several types of cancer, and the steep physician learning curve associated with PET. However, we do not believe that PET and MRI compete with one another as MRI is primarily used for diagnosing musco-skeletal injuries. Furthermore, we believe that PET and CT are complementary, as evidenced by the development of the combined PET/CT scanner.

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

      Sales of PET imaging equipment and related products and services have grown rapidly and are expected to continue to grow rapidly. Based on 2001 and 2003 market analyses prepared by Frost & Sullivan, a marketing consulting firm, the estimated installed base of PET scanners in the U.S. grew from 107 in 1997 to 849 in 2002, and the estimated number of units shipped annually in the U.S. grew from 12 in 1997 to 299 in 2002. The Frost & Sullivan analysis forecasts that from 2002 through 2009 the U.S. installed base of PET scanners will grow at an estimated compound annual growth rate of 27.4%, and the number of units shipped in the U.S. will grow at an estimated compound annual growth rate of 19.0%.

      One of the principal reasons for growth in the PET market is the increasing number of PET applications being approved for reimbursement by third-party payors, such as Medicare, national and local private insurers and HMOs. Reimbursement is critical to increasing the adoption rate of PET by clinicians. Through active educational efforts, industry participants and associations, such as the Academy for Molecular Imaging, the Society of Nuclear Medicine and the Radiological Society of North America as well as the National Institutes of Health, have been successful in increasing the awareness of PET’s benefits to patients, physicians and members of the payor community and in increasing the number of PET applications for which reimbursement is available. On July 1, 2001, the Centers for Medicare and Medicaid Services (CMS), which administers Medicare and Medicaid, expanded its policy to cover PET scanning in six oncology applications, two cardiac applications and one neurological application. Effective October 1, 2002, CMS expanded coverage for breast cancer and heart disease. Most recently, on April 16, 2003, and effective as of October 1, 2003, CMS announced expansion of Medicare coverage for PET to include thyroid cancer and patients with potential cardiac disease.

      The following table summarizes the PET applications that have been approved for reimbursement by CMS. As used in the following table, the term “staging” generally refers to the use of PET in the initial diagnosis process to verify the existence and status of the disease. The term “restaging” generally refers to

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

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

      We also expect new innovations involving PET. Research and development activities in the industry are focused on decreasing scan times, thereby increasing patient throughput capacity and improving patient comfort and image quality. For example, by using detectors made from lutetium oxyorthosilicate, or LSO, rather than the traditional detector material, bismuth germanate, or BGO, scan times for certain routine procedures have decreased from approximately thirty minutes to approximately ten minutes. Other research and development activities focused on improving image quality resulted in the commercial introduction of a combined PET/CT scanner. The combination of PET and CT technologies in a single scanner results in better diagnostic and therapy monitoring capability than either technology alone and allows physicians to identify the location of biologic abnormality with more precision. By pinpointing the location of malignant tumors and providing clearer images, we believe the combined PET/CT has the potential to revolutionize both the practice and business of cancer treatment by, for example, facilitating concurrent tumor ablation or resection.

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

Business Strategy

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

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

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

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

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

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

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

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

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

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

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

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

	•	develop new varieties of radiopharmaceuticals to be used as biomarkers to characterize the varied pathways of diseases and extend the use of PET imaging to additional diseases;
	•	collaborate with leading pharmaceutical companies and academic institutions to, among other things, improve their process for conducting research and clinical trials; and

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	•	explore new therapeutic applications for PET.

Our Products and Services

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

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

      Our subsidiary, CPS, manages the development, manufacturing, distribution and sale of the ECAT® line of PET scanners. This line of scanners consists of stand-alone PET scanners and the combined PET/CT scanner. The scanner system consists of a scanner frame known as the gantry, a patient bed, an acquisition computer and a high-speed operator’s workstation. The ECAT® scanner line performs simultaneous acquisition, image reconstruction, processing, and data analysis, which enhances patient throughput and generates prompt results. The scanners produced by CPS range in price from $800,000 to $2.4 million and offer customers a range of throughput times, resolution and image quality. With the variety in pricing and function, we are able to meet the needs of small and mid-sized imaging centers, as well as larger facilities that require more extensive equipment for clinical research purposes. For a discussion of segment financial information, see “Segments” in note 13 of the notes to our consolidated financial statements appearing elsewhere in this annual report.

      We are the only manufacturer of lutetium oxyorthosilicate, or LSO, as a detector material for use in our PET scanners. LSO is a lutetium based scintillator material the chemical compound of which was patented by Schlumberger Technology Corporation. By using LSO as a detector material in our products, our scanners provide improved performance and diagnostic accuracy by decreasing patient scan times and increasing image quality. We have exclusive rights to the development and manufacturing of LSO as a detector material. We acquired these exclusive rights from Schlumberger in February 1995. The exclusive rights terminate upon the expiration of Schlumberger’s patents for LSO, which are currently scheduled to expire in October 2008. While LSO is the only lutetium based scintillator material currently used in the PET industry, it may be possible for others to produce a lutetium based detector that does not contain LSO without violating the Schlumberger patent and, therefore, our exclusive license. Previously we manufactured bismuth germanate, or BGO, a detector material, which is still used in competitive scanners.

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

      Through our PETNET subsidiary, we currently operate 39 radiopharmaceutical production and distribution centers, referred to as PETNET radiopharmacies, located in major metropolitan areas across the U.S. and one radiopharmaceutical production and distribution center in the United Kingdom. Of our 40 radiopharmacies, we operate 13 cyclotrons owned by others, or hosts, pursuant to contracts. Our PETNET radiopharmacies principally produce and distribute FDG, which is used in oncology, cardiology and neurology applications, but these radiopharmacies can also manufacture and distribute research radiopharmaceuticals. Our PETNET radiopharmacies allow customers to obtain a cost effective source of radiopharmaceuticals without having to purchase and operate their own cyclotron. In addition, our nationwide network of distribution centers provides our customers with assurance that their radiopharmaceutical requirements will be satisfied in a timely manner that reduces scanner downtime and facilitates patient scheduling. We also provide various PET-related services through PETNET, including reimbursement education, radiation safety consulting, licensure assistance and marketing assistance. We believe that the demand for radiopharmaceuticals will expand with the future growth of the PET market and the growing demand for PET services. To meet this demand, we expect to continue the expansion of our PETNET network.

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

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

      Mirada Workstations. Through our subsidiary, Mirada Solutions Limited, we produce Mirada workstations with Reveal-MVS. Reveal-MVS is software designed to improve the patient care delivered by our customers with innovative, unique and productive tools for the creation, display and analysis of molecular images.

      Concorde MicroPET. We have, through PETNET, an exclusive, royalty-free license agreement to distribute products of Concorde Microsystems, Inc., a related party, within certain territories, including high-resolution animal PET tomography scanners (MicroPET). MicroPET provides researchers in the biomedical sciences with a compact and very high performance PET system that can be used non-invasively to image a wide range of small animals in a routine laboratory setting. PETNET is responsible for sales, marketing and education activities, while Concorde is responsible for all product warranty, installation, training, service and technical support.

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

	Repair and Maintenance Services. We offer our customers the opportunity to enter into long term service contracts with us pursuant to which we agree to provide repair and maintenance services, including scheduled preventive maintenance, troubleshooting and problem diagnosis, service and repair procedures and replacement parts installation. Approximately 150 PET scanners are under contract for repair and maintenance services at an average price of $119,000 per year. Equipment maintenance service contracts are recognized ratably over the respective contract periods as the services are performed.
	Site Planning and Installation Services. Prior to installing a PET scanner, we assist our customers with the development of their sites by providing pre-installation site inspections, consultation with facility architects, construction management services, system requirement and

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

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Research & Development

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

      Our research and development team focuses on developing the next generation of PET scanners, cyclotrons and radiopharmaceuticals. In addition to our internal ideas, our research and development department collaborates with a network of leading physicians, academic imaging experts and, in the case of CPS, with Siemens. We actively involve scientists and physicians during the research and development process in order to produce products that are truly customer driven and customer focused. We incurred $31.3 million in 2003, $21.7 million in 2002 and $19.0 million in 2001 in research and development expenses, including clinical and regulatory expenses.

      In order to enhance our research capabilities, we have also entered into collaboration arrangements with a number of universities and research institutions. For example, in 1994 we entered into a collaboration agreement with UCLA for the development of new molecular imaging technology. This relationship has led to a number of breakthrough developments in molecular imaging, from imaging the expression of genes to the development of new experimental radiopharmaceuticals. For example, our image of Alzheimer’s-related plaques using a new radiopharmaceutical was selected as the image of the year in 2001 by the Society of Nuclear Medicine. CPS also worked with Dr. David Townsend at the University of Geneva, who was named the “Distinguished Clinical Scientist of the Year for 2004” by the Academy of Molecular Imaging, to develop the PET/CT, which was recognized by TIME Magazine as the medical science “Invention of the Year” in 2000. Further, CPS worked with the Max Planck Institute in Germany to develop the first large field of view clinical scanner in 1990 and, more recently, a 2mm brain scanner used for neurological research. These collaboration arrangements have increased our access to world-class physicians and scientists and have given us a platform to expand our name recognition in the scientific and medical communities and to increase understanding among physicians of the benefits of PET.

      Our role as a leader in the area of research and development is exemplified by the academic and research institutions that use our products. Today, our products are used by many of the leading medical

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Products Under Development

      CPS develops dedicated PET scanners that use our advanced LSO-based detector materials. These scanners provide substantially higher patient throughput while providing improved image quality and upgradeable performance. CPS also develops PET/CT scanners that incorporate advanced LSO-based detector systems. Future PET/CT scanners are expected to better integrate PET and CT technologies and are anticipated to substantially decrease body scan time to be consistent with the scan times of a CT while improving image quality.

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

      In order to further enhance our role as a leader in developing new PET technology and radiopharmaceuticals, PETNET has established a collaborative research and development facility with the UCLA School of Medicine. We refer to this facility as the LA Tech Center. One of the goals of the LA Tech Center’s research is to establish new biomarkers that will eventually allow medical personnel to probe the various pathways of disease, using methods similar to those used today by in vitro laboratory techniques. Another primary goal of the LA Tech Center is to expand the use of PET technology to accelerate the drug development process. We believe PET has a number of advantages over other imaging modalities that will allow pharmaceutical companies to use PET to more quickly identify whether their developmental drugs are reaching their intended targets and achieving the desired therapeutic results. We anticipate that the use of PET by pharmaceutical companies could help to improve their success rate in clinical trials and speed up the drug development process. In addition, by increasing the labeled pharmaceuticals available in the PET imaging modality, we expect the process will result in increasing the number of radiopharmaceuticals for use in PET imaging.

Our Relationship with Siemens

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

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

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      The exercisability of the put/call right 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 September 30, 2003, the cumulative total number of units sold by CPS was 697 and CPS would need to have sold a cumulative total of 981 units to achieve the required cumulative sales level for the put/call right to be exercisable. The cumulative unit sales requirement increases by 74 units each year. It is impossible to definitively state when the put/call right will become exercisable by either party. However, based upon our current forecasts, we believe it is unlikely that the minimum sales volumes will be met in 2005. Assuming that sales volumes are met in 2005 and further assuming the exercise of the one-year deferral right, the sale of CPS is not expected to occur before 2006.

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

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

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

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

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

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

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

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

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

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

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

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

      Siemens served as our exclusive distributor of ECAT® scanners from 1987 to 1997. From 1997 until 2001, Siemens and CPS served as the only distributors of ECAT® scanners. In 2001, CPS adopted a multiple distributor strategy in order to expand its distribution channels. In November 2001 we added Hitachi Medical Systems America, Inc. as a third-party distributor of CPS’ products and in October 2003 we added Toshiba Medical Systems Corporation as a third-party distributor of CPS’ products in Japan. As a result, we are now serving as a direct distributor of the products manufactured by CPS. Our distribution agreement with CPS grants us a non-exclusive worldwide right to distribute PET scanners manufactured by CPS. Pursuant to the terms of our distribution agreement, CPS has an obligation to sell scanners to us at a price that is no less favorable than the price offered by CPS to any of its other distributors based on

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

      Pursuant to the terms of our revolving credit facility with SunTrust Bank, CPS is allowed to borrow up to $55.0 million under the credit facility to finance its operations. At September 30, 2003, CPS had no outstanding balance under the credit facility. CPS pays its pro rata portion of all fees and commissions under this credit facility. Our subsidiaries guarantee all obligations under the credit facility, except that the guarantee by CPS is limited to $55.0 million and does not include any advances under the credit facility that are loaned (on an intercompany basis) to our PETNET subsidiary. The credit facility and the obligations of our subsidiary guarantors under the credit facility are secured by a lien on substantially all of our assets (including the capital stock or other forms of ownership interests we hold in our subsidiaries) and the assets of our subsidiary guarantors, except that the lien securing the guarantee of CPS is principally limited to the accounts receivable and inventory of CPS.

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

Competition

      The primary competitive factors in the PET equipment market are quality, technical capability, breadth of product line, distribution capabilities, price, the ability to offer vendor financing, and the ability to provide quality service and support. Our principal competition in the market for PET scanners comes from divisions or subsidiaries of much larger corporations such as GE Medical Systems and Philips Medical Systems. GE Medical Systems markets and sells a combined PET/CT, which is the main competitor to the PET/CT manufactured by CPS. We also compete with Siemens in connection with the sale and distribution of the PET scanners manufactured by CPS, as well as for service and support business. Our competitors also include academic institutions and other public and private research organizations that conduct research, seek patent protection and establish arrangements for commercializing products that compete with our products. We are a relatively modest-sized company compared to our primary competitors in the PET equipment market, GE Medical Systems and Philips Medical Systems. These two competitors have substantially greater access to capital and the ability to bundle PET sales with the sale of other medical devices in their respective product lines. However, they both have more limited PET product lines than CTI. Because we offer a comprehensive, integrated line of PET related products and services that complement our PET scanners, we believe we have some competitive advantages over these and other competitors with more limited PET product lines. We also believe that our position as a technological leader in the PET industry helps us to compete in the market for PET scanners.

      We believe the primary competitive factors in the radiopharmaceutical market are national distribution capabilities, reliability of delivery, price, the ability to develop new radiopharmaceuticals and the ability to obtain proprietary rights to any newly developed radiopharmaceuticals and cyclotron technology. In the radiopharmaceutical market, we have three principal groups of competitors. The first

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

Sales and Marketing

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

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

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

      For fiscal years 2003, 2002 and 2001, our revenues from U.S. sales were $278.0 million, $197.7 million and $144.7 million, respectively. For fiscal years 2003, 2002 and 2001, our revenues from sales outside the U.S. were $84.3 million, $60.7 million and $44.2 million, respectively, and substantially all of our long-lived assets, were located in the U.S. Sales through Siemens represented approximately

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      Firm backlog orders at September 30, 2003 and September 30, 2002 were $190.6 million and $112.2 million, respectively. A majority of this backlog is expected to be realized as revenues by the end of the 2004 fiscal year.

Customer Service and Support

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

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

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

Intellectual Property

      Our future growth and ability to compete in the molecular imaging market are substantially dependent on internally developed technologies. We seek to protect our technology through a combination of copyright, patent, trademark, trade secret and other intellectual property laws. As of September 30, 2003, we held 30 U.S. patents and have 26 patent applications pending, which are generally related to our PET scanners, cyclotrons and radiopharmaceutical production. We believe it could take up to four years, and possibly longer, for our pending U.S. patent applications to result in issued patents. Certain technologies already patented in the U.S. are either patented or subject to pending patents in Europe, Canada and Japan. We have also received trademark registrations for “CTI”, “ECAT” and our logo. We also rely on trade secrets and other unpatented proprietary information, which we attempt to protect by entering into confidentiality agreements with certain employees, consultants, suppliers, distributors, and other partners. We also seek to control access to and distribution of our documentation and other proprietary information.

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

Manufacturing

      CPS assembles our ECAT® and REVEAL scanners, and we assemble cyclotrons, from components manufactured by us and components supplied to us by suppliers to whom we have outsourced portions of our manufacturing process. For our scanners, the most significant internal manufacturing process involves the production of detector materials, which includes several proprietary processes. Examples of components

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      A number of components used in our existing products, as well as products under development, are purchased from single sources. For example, we purchase a substantial portion of the raw material used to create our LSO detector material from a single source. Disruptions or loss of supply from any of our single source suppliers could disrupt our manufacturing process or cause significant unanticipated costs in obtaining alternative components or in incorporating alternative components into our production process.

      Our facility and quality system is inspected by TÜV Essen, which is an independent auditing firm responsible for granting accreditations of European Union medical devices and quality assurance systems. Our facility and CAN/CSA ISO 13485:1998 quality assurance systems have been found by TÜV Essen to conform to the requirements of ISO-9001: 2000, ISO 13485: 1996, and the European Union Medical Device Directive.

Government Regulation

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

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

      In some states, a certificate of need or similar regulatory approval is required prior to the acquisition of high-cost capital items or services, including diagnostic imaging systems or provision of diagnostic imaging services by our clients. Certificate of need regulations may limit or preclude our clients from providing diagnostic imaging services or systems. At present, a number of states in which we sell PET systems have certificate of need laws that restrict the supply of PET systems and other types of advanced medical equipment. Certificate of need laws were enacted to contain rising health care costs, prevent the unnecessary duplication of health resources, and increase patient access for health services. In practice,

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

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

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

      If human clinical trials of a device are required for a 510(k) submission and the device presents a significant risk to the patient in the trial, the sponsor of the trial, usually the manufacturer or the distributor of the device, must file an investigational device exemption application prior to commencing human clinical trials. The investigational device exemption application must be supported by data, typically including the results of animal and/or laboratory testing. If the investigational device exemption is allowed to go forward by the FDA and one or more appropriate institutional review boards, human clinical trials may begin at a specific number of investigational sites with a specific number of patients, as detailed in the investigational device exemption. If the device presents an insignificant risk to the patient, a sponsor may begin the clinical trial after obtaining approval for the study by the institutional review boards alone. Submission of an investigational device exemption does not give assurance that the FDA will allow the investigational device exemption to progress and if allowed to progress there can be no assurance the FDA will determine that the data derived from the studies supports the substantial equivalence of the device or warrants the continuation of the clinical trials. An investigational device exemption supplement must be submitted to the FDA before a sponsor or investigator may make a change to the investigational plan that may affect its scientific soundness, study indication or the rights, safety or welfare of human subjects.

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

      Cyclotrons. We believe that our cyclotrons are manufacturing equipment, rather than medical devices as defined under the Food, Drug and Cosmetic Act (i.e., they are not intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease, or intended to affect the structure or any

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      Radiopharmaceuticals. Our PET radiopharmaceutical products currently are produced and sold through our PETNET radiopharmacies, which operate under applicable state pharmacy licenses and compound PET products in response to the prescription order of a licensed practitioner. The Food and Drug Administration Modernization Act of 1997 (the “1997 Act”) authorized the production of PET products that conform to the United States Pharmacopoeia (USP) positron emission tomography compounding standards and the official monographs of the USP. Under these terms, we are manufacturing and distributing several PET products.

      FDA generally requires sponsors to submit a new drug application prior to marketing a drug to demonstrate that the drug is safe and effective for its intended uses. FDA will approve the new drug application only if the drug’s safety and effectiveness has been demonstrated by extensive, controlled clinical data, or by references to such data, and the sponsor has shown adequate manufacturing and controls. A sponsor may also submit an abbreviated new drug application, which does not require safety and effectiveness data, but generally requires a demonstration that the drug is “bioequivalent” to an already approved drug. Under the 1997 Act, FDA currently cannot require the submission of a new drug application or abbreviated new drug application for any compounded PET product that conforms to the PET compounding standards and the official monographs of the USP until two years after the agency adopts appropriate new drug approval procedures and current good manufacturing practice requirements for these products.

      On March 10, 2000, FDA published a Federal Register notice announcing that the agency has concluded that certain commonly used PET products (e.g., FDG injection) are safe and effective for certain indications when produced under conditions specified in approved new drug applications and abbreviated new drug applications. In that notice, FDA invited producers of these products to voluntarily submit applications for marketing approval and set out the approval procedures and type of application required for these PET products. FDA stated that the agency has not yet addressed the procedures for approval of other PET products and of new indications for approved PET drug products.

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

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

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

      Until FDA adopts final current good manufacturing practice requirements for PET products, it is uncertain whether any such requirements will have a material impact on our radiopharmaceutical business. However, we may incur significant costs in establishing and maintaining procedures and in certain facilities

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

      In order to market our products in European and other foreign countries, we must obtain required regulatory approvals and comply with extensive regulations governing product safety, quality and manufacturing processes. These regulations vary significantly from country to country and with respect to the nature of the particular medical device. The time required to obtain these foreign approvals to market our products may be longer or shorter than that required in the U.S., and requirements for licensing may differ from FDA requirements.

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

      All of our products sold internationally are subject to appropriate foreign regulatory approvals, like CE marking for the European Union. Our products are manufactured in ISO 9001: 2000 and ISO 13485: 1996 and CAN/CSA ISO 13485: 1996 certified facilities.

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

      Our scanners, cyclotrons, and radiopharmaceutical business require the use of radioactive materials, and our cyclotrons are utilized to produce radioactive materials. While the radioactive materials utilized in our radiopharmaceuticals have relatively short half-lives, meaning it quickly breaks down into inert, or non-radioactive substances, the storage, use, and disposal of these materials presents the radiation risk for our employees and the risk of accidental environmental releases. 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

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

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

      All third-party reimbursement programs, whether government funded or insured commercially, whether inside the U.S. or outside, are developing increasingly sophisticated methods of controlling health care costs through prospective reimbursement and capitation programs, prior authorization of procedures, group purchasing, redesign of benefits, requiring second opinions prior to major surgery, careful review of bills, encouragement of healthier lifestyles and exploration of more cost-effective methods of delivering health care. In August 2000, CMS implemented the Hospital Outpatient Prospective Payment System in an effort to control costs to the Medicare program. The Hospital Outpatient Prospective Payment System applies to items and services furnished in hospital outpatient departments and other facilities that are considered to be “provider-based.” Under this new system, items and services are grouped into ambulatory payment classifications (“APC”), with most ambulatory payment classifications having a pre-determined payment rate based on historical cost and charge data. The hospitals bill for items and services using Healthcare Common Procedure Coding System codes, and these codes are used to determine the ambulatory payment classifications that are paid for the billed items and services. In order to accommodate new technologies, additional payments are made for “new technology” services and for drugs, biologicals and devices that are eligible for “pass-through” payments. “New technology” services are paid as part of special cost-based ambulatory payment classifications while CMS collects sufficient data to determine the appropriate ambulatory payment classification for the service. Separate payments are made for pass-through items for two to three years, after which they will be incorporated into ambulatory payment classifications.

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

      In addition, non-governmental third-party payors, such as commercial health maintenance organizations, preferred provider organizations and other insurers, may similarly impose varying requirements and

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

      On April 16, 2003, CMS announced that it affirmed its prior non-coverage decision of the application of PET to Alzheimer’s disease, saying that the clinical benefit of PET has not yet been demonstrated. However, CMS announced two special efforts to help determine the potential of PET for Alzheimer’s disease. A demonstration will be designed to evaluate the appropriate role of PET in patients with suspected dementia and CMS will work with the National Institutes of Heath to convene a multidisciplinary expert meeting with geriatricians, neurologists, radiologists, PET experts and patient advocates to fully explore the value of PET for Alzheimer’s disease. The CMS decision was consistent with our expectation that gaining reimbursement approval for Alzheimer’s disease will take some time. On August 14, 2003, a new and more restrictive coverage request for the use of PET in the diagnosis of mild to moderate Alzheimer’s disease was filed with CMS. On October 7, 2003, CMS formally accepted this request and indicated that an expected completion date for the new coverage decision of January 2004. We remain confident that CMS will provide coverage of PET in Alzheimer’s disease as there is evidence from scientists representing the Academy of Molecular Imaging that PET is the only technology available that can definitively diagnose Alzheimer’s disease.

      The federal health care program’s anti-kickback law, the Anti-Kickback Law, prohibits persons from knowingly and willfully offering, paying, soliciting, or receiving remuneration, directly or indirectly, in exchange for or to induce either: (i) the referral of an individual, or (ii) the purchasing, leasing, ordering, or arranging for, or recommending the purchase, lease or order of, any service or item for which payment may be made by Medicare, Medicaid or certain other federal health care programs. The definition of “remuneration” has been broadly interpreted to include gifts, discounts, the furnishing of free supplies or equipment, commercially unreasonable credit arrangements, payments of cash and waivers of payments. The statute itself has been broadly interpreted to mean that if any one purpose of a payment arrangement is to induce referrals of federal health care program covered business, the statute has been violated. The penalties for violating the Anti-Kickback Law can be severe. These sanctions include criminal penalties and civil sanctions, including fines and imprisonment.

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

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

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

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

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

      Congress has also passed significant prohibitions against certain physician referrals of patients for health care services. These prohibitions are commonly known as the Stark Law. The Stark Law prohibits a physician from making referrals for particular health care services (called designated health services) to entities with which the physician, or an immediate family member of the physician, has a financial relationship. If an arrangement is covered by the Stark Law, the requirements of a Stark Law exception must be met for the physician to be able to make referrals to the entity for designated health services.

      The term “financial relationship” is defined very broadly to include most types of ownership or compensation relationships. The Stark Law also prohibits the entity receiving the referral from seeking payment under the Medicare and Medicaid programs for services rendered pursuant to a prohibited referral. If an entity is paid for services rendered pursuant to a prohibited referral, it may incur civil penalties and could be excluded from participating in Medicare or Medicaid.

      As originally enacted, the Stark Law restricted referrals for clinical laboratory services. This version of the Stark Law is also called Stark I. Effective January 1, 1995, the Stark Law was expanded to include physical therapy services; occupational therapy services; radiology services, including magnetic resonance imaging (MRI), computerized axial tomography (CAT) scans, and ultrasound services; radiation therapy

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      The Stark Law defines a financial relationship to include (1) a physician’s ownership or investment interest in an entity and (2) a compensation relationship between a physician and an entity. Under the Stark Law, financial relationships include both direct and indirect relationships. We have various compensation arrangements with physicians, including consulting agreements, research and development agreements, and lease agreements. Also, we have a number of joint venture arrangements to establish and operate PETNET radiopharmacies. In connection with these different arrangements there are physicians who would have a financial relationship with us under the Stark Law. Accordingly, these physicians would not be able to refer patients to us for designated health services unless a Stark Law exception applies.

      The definition of “designated health services” includes “radiology services, including magnetic resonance imaging, computerized axial tomography and ultrasound services.” On January 4, 2001, HHS issued final regulations to the Stark II provisions of the Stark Law. These regulations became effective on January 4, 2002. The final regulations exclude from the definition of covered designated health services “nuclear medicine services and supplies.” We believe that this exclusion covers the equipment and services we provide.

      HHS has accepted comments to the Stark II final rules and has stated that it will issue further regulations to the Stark Law in the future. In addition, HHS has indicated that it will propose new regulations to amend the definition of “radiology and certain other imaging services” to include diagnostic nuclear medicine services and supplies. If enacted, this amendment would mean that our nuclear medicine services and supplies would be included under the definition of designated health services under the Stark Law. We cannot predict whether HHS will implement this amendment or will adopt additional regulations that affect our business.

      If the Stark Law applies to the relationships between us and referring physicians, there are exceptions to the Stark Law which, if certain requirements are met, would permit those physicians to refer patients to us for designated health services. The Stark Law contains exceptions for certain physician ownership or investment interests in entities and certain physician compensation arrangements with entities. The exceptions for compensation arrangements include employment relationships, personal services contracts, and space and equipment leases. If a compensation arrangement between a physician, or immediate family member, and an entity satisfies all requirements for a Stark Law exception, then the Stark Law will not prohibit the physician from referring patients to the entity for designated health services. We believe that our compensation and joint venture arrangements with physicians who refer to us would meet or could be restructured to meet the requirements for an exception under the Stark Law.

      If an entity violates the Stark Law, it could be subject to civil penalties of up to $15,000 per prohibited claim and may be excluded from participation in Medicare and Medicaid. If the Stark Law applies to the relationships between us and our referring physicians and no exceptions under the Stark Law are available, then we will be required to restructure these relationships or refuse to accept referrals for designated health services from these physicians. If we were found to have submitted claims to Medicare for services provided pursuant to a referral prohibited by the Stark Law, then we would be required to repay amounts received from Medicare for those services and could be subject to civil monetary penalties. If we were required to repay amounts to Medicare or were subject to fines, the Company could be harmed.

      Many states have physician relationship and referral statutes that are similar to the Stark Law. We believe we are in substantial compliance with applicable state laws on physician relationships and referrals. However, any finding that we are not in compliance with these state laws could require us to change our operations and could have a negative impact on us.

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

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

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

      The security regulations promulgated pursuant to HIPAA were finalized on February 20, 2003 and covered entities are required to be in compliance with them by April 21, 2005. The purpose of the proposed security regulations is to establish a minimum standard for the protection of individual health information that is stored or transmitted electronically. The regulations provide administrative procedures, physical safeguards, and technical mechanisms that may be implemented to satisfy the regulations.

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

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

Employees

      As of September 30, 2003, we employed directly and through our subsidiaries 915 people. Of these 915 people, 283 work in our PET scanner manufacturing business, 226 work in our radiopharmaceutical

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Available Information

      Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available through our website (www.ctimi.com) under the “Investor Relations” caption free of charge as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). We are not including the information on our website as a part of, nor incorporating it by reference into, this Form 10-K.

Item 2.     Properties

      We currently own 201,000 square feet of office, research and development, manufacturing and warehouse space in Knoxville, Tennessee, and 63,000 square feet of production space in Rockford, Tennessee. We have entered into a lease for approximately 22,000 square feet of additional office space and 10,000 square feet of warehouse space in Knoxville, Tennessee. Except for the space located in Rockford, Tennessee, which is used primarily by our Detector Materials segment, each of the foregoing facilities is used in part by each of our financial reporting segments.

      CPS leases office, research and development, manufacturing and warehouse space in Knoxville, Tennessee from CTI under a lease agreement which runs through December 31, 2012. During 2003, CPS purchased approximately 21,000 square feet of office and warehouse space located in Rockford, Tennessee.

      We currently lease space for 30 PETNET radiopharmacies throughout the U.S., including metropolitan areas such as New York, Chicago, Tampa, San Francisco, Los Angeles, Phoenix, Dallas, Detroit and Nashville. Four of these leased properties are locations for future radiopharmacies. We operate 13 of our radiopharmacies in facilities that are owned by other parties and for which our use of the facilities is governed by our commercial agreements with those parties rather than separate facility leases. In addition, we have a PETNET radiopharmacy located in Mount Vernon, United Kingdom.

      CTI Services has offices in Europe that house sales and service personnel who provide support for products sold in Europe. These facilities are used by our CTI Services segment.

Item 3.     Legal Proceedings

      In May 2002, Cox Nuclear Pharmacy, Inc. & Accuscan LLC filed an action against CTI, PETNET Pharmaceuticals, Inc. and an employee of PETNET, in the United States District Court for the Southern District of Alabama, Southern Division, civil action no. 02-cv-0321-CG-C. The plaintiffs 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 violation of a covenant not to compete in the Mobile, Alabama market. The plaintiffs sought $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 against the PETNET employee have been dismissed. On December 5, 2003, the District Court granted summary judgment against the plaintiffs as to all remaining claims but leaving unaffected CTI’s counterclaim for liquidated damages under CTI’s purchase order with the plaintiffs.

      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

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      On September 19, 2002, General Electric filed a complaint against two former employees of General Electric who are now employed by CTI in the United States District Court, Eastern District of Wisconsin. The complaint alleged threatened or actual misappropriation of trade secrets, breach of contract and unfair competition. CTI was not named as a defendant in that action. The defendants answered the complaint and denied liability. On September 23, 2003, the District Court in Wisconsin granted General Electric’s motion for voluntary dismissal without prejudice, which afforded General Electric an opportunity to refile the action in another United States District Court and potentially include additional defendants in addition to the two former employees. On November 24, 2003, General Electric refiled this action in the United States District Court for the Eastern District of Tennessee, Knoxville Division, against the two employees, CTI and PETNET. The defendants filed their motion for dismissal against all of GE’s claims on December 15, 2003. Due to the early stage of this action we are not able at the present time to render an opinion as to the likelihood of an outcome unfavorable to CTI or PETNET or as to the amount or range of potential loss by CTI or PETNET in the event of an unfavorable outcome, but we intend to vigorously contest 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.

      No matter was submitted to a vote of security holders during the fiscal quarter ended September 30, 2003.

PART II

Price Range of Common Stock

      The Company’s Common Stock has been traded on the Nasdaq National Market (Nasdaq symbol: CTMI) since June 21, 2002. The following table sets forth the high and low sales prices as reported on the Nasdaq National Market for quarter ends during our 2003 and 2002 fiscal years.

Holders

      The number of record holders of the Company’s Common Stock at December 1, 2003 was 137, excluding beneficial owners of shares registered in nominee or street name.

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Dividend Policy

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

Securities Authorized for Issuance Under Equity Compensation Plans

      The following table summarizes our equity compensation plans as of September 30, 2003:

(1)	Includes up to 5,928 shares that may be granted as awards of restricted stock, performance shares or unrestricted stock under the 2002 Long-Term Incentive Plan.
(2)	Includes warrants to acquire 76,000 shares issued in connection with the execution of a consulting agreement and 374,506 options issued outside of our 1998 Amended and Restated Incentive Stock Option Plan to certain non-employee advisors and consultants. See “Stock Options, Warrants and Restricted Stock” in note 9 of the notes to our consolidated financial statements appearing elsewhere in this annual report

Sales of Unregistered Securities

      During the year ended September 30, 2003, we had no sales of unregistered securities.

Use of Offering 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 $16.0 million was approximately $171.4 million. As of September 30, 2003, $10.2 million of the net offering proceeds had been used to redeem all of our Series A Redeemable Preferred Stock, including all accrued dividends, $0.3 million of the net offering proceeds had been used to redeem 1,191,165 shares of our common stock, approximately $62.0 million of the net offering proceeds had been used to decrease our outstanding balance under our credit facility, approximately $14.5 million had been used to extinguish capital lease obligations, and $11.4 million was used to repay our construction loan and our mortgage loan agreement. In addition, approximately $19.6 million was used for the acquisition of our subsidiary Mirada Solutions Limited in August 2003. The balance of the net offering proceeds have been invested in highly liquid instruments, such as commercial paper and U.S. government obligations, with an average maturity of twelve months or less.

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

      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

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

Overview

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

      Historically, the majority of our consolidated revenues, gross margin and net income have been attributable to our CPS segment. Our strategy includes plans for growing our other segments over time with a goal of having greater than 50% of our gross revenues and net income being derived from such other segments by 2006, the expected year that Siemens’ could first close on the exercise of its option to purchase 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, such as Mirada workstations.

      We operate in four segments for financial reporting purposes: CPS; PETNET; Detector Materials, and CTI Services. In addition, we have other business operations that are not classified as separate segments for financial reporting purposes, including general corporate activities. Effective October 1, 2003, the PETNET and CTI Services segments have been combined to reflect organizational changes. In future fiscal reporting periods these two segments will be reported as one segment, CTI Solutions.

      Our CPS segment includes the development, production and sale of PET and PET/CT scanners. We conduct this business through our subsidiary, CTI PET Systems, Inc. which does business as CPS Innovations (CPS) and which was formed in 1987 as a joint venture with Siemens Medical Solutions USA, Inc., a wholly owned subsidiary of Siemens, AG. We own 50.1% of 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, we set the price to the end customer, had ultimate liability to the end customer for product performance, and retained credit risk associated with sales to end customers.

      In April 2001 we implemented a multiple distributor strategy for CPS by commencing direct distribution and by pursuing additional third-party distributor agreements. In November 2001 we added Hitachi Medical Systems America, Inc. as a third-party distributor of CPS’ products, and in October 2003 we added Toshiba Medical Systems Corporation as a third-party distributor of CPS’ products in Japan.

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      The scanners manufactured by CPS have historically ranged in customer price from $800,000 to $2.4 million and offer customers a broad range of throughput times, resolution and image quality.

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

      We currently operate 39 PETNET radiopharmacies in the U.S. and 1 radiopharmacy in the United Kingdom. Thirteen 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 40 radiopharmacies PETNET operates also include three radiopharmacies we do not consolidate. While PETNET owns 50.1% of these radiopharmacies, we do not exert significant influence to control the activities of these three radiopharmaceutical production and distribution facilities.

      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 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 expected increased demand for detector materials as the PET market continues to grow. ACT previously manufactured bismuth germanate, or BGO, the primary detector material used in PET scanners manufactured by CPS prior to the introduction of LSO.

      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 subsidiaries in Germany, Spain, Italy and the United Kingdom that distribute and service our products in Europe; our subsidiary in South Korea that distributes our services and products in South Korea; and Mirada Solutions Limited which develops and sells imaging workstations and which we acquired in August 2003.

      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

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      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 40 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 shipping, installation, acceptance, and warranty of our products; royalties payable under technology licenses; and fixed asset depreciation, primarily for our detector materials and radiopharmacies.

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

      Research and Development. Significant investment in research and development has been made, and we believe will continue to be required, to develop new products and enhance existing products to allow us to further penetrate the PET market. These expenses consist primarily of salaries and related personnel expenses; expenditures for prototype materials and supplies; overhead 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.

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

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

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