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United States
Securities and Exchange Commission

Form 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number:           000-49867

CTI MOLECULAR IMAGING, INC.

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

As of February 2, 2004, the registrant had outstanding 45,426,459 shares of common stock, par value $0.01.

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

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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 December 31, 2003;
	•		our critical accounting policies;
	•		the timing of the exercisability of the Siemens option to purchase an additional ownership interest in CTI PET Systems, Inc. (CPS) and the effect of the Siemens option, or its exercise, on our business;
	•		our expectations regarding the size and growth of the market for our products and services 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 I, Item 2 of this report under the sub-heading “Factors Affecting Operations and Future Results.”

     You should read this report, the information incorporated by reference into this report and the documents filed as exhibits to this report completely and with the understanding that our actual future results or achievements may be materially different from what we 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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CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

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

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

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

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

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

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

1.     Organization and Presentation

     The unaudited condensed consolidated financial statements include the accounts of CTI Molecular Imaging, Inc. (CTI) and all of its subsidiaries (the Company). All of the subsidiaries are wholly owned except for CTI PET Systems, Inc. (CPS) in which CTI owns 50.1%. The balance of CPS is owned by Siemens Medical Solutions USA, Inc. (Siemens).

     The Company’s products and services can be broadly classified into three principal categories: Positron Emission Tomography (PET) scanners, detector materials, and other PET products and services. CPS manages the development, production and distribution of the ECAT® line of PET scanners. Detector Materials develops and manufactures detector materials used in PET scanners manufactured by CPS. CTI Solutions includes the production and distribution of radiopharmaceuticals and the direct sale and service by CTI of PET scanners, cyclotron systems, workstations and other PET related products. The CTI Solutions segment was formed effective October 1, 2003 and reflects the combination of the former CTI Services and PETNET segments, which previously were separately reported.

2.     Summary of Significant Accounting Policies

     Interim Financial Statements — The unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on December 23, 2003. Information in the accompanying condensed consolidated financial statements and notes to the financial statements for the three month periods ended December 31, 2003 and 2002 are unaudited. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of financial position, results of operations and cash flows for the periods presented have been included. Operating results for the three month period ended December 31, 2003 are not necessarily indicative of the results that may be expected for the year ending September 30, 2004 or any future period.

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

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

     CTI Solutions through our subsidiary, PETNET Pharmaceuticals, Inc. (PETNET), owns 90.0% and 51.0% interests in radiopharmacies in Denver and Houston, respectively. Under the terms of the Denver and Houston radiopharmacy operating agreements, CTI Solutions has control over all significant operating decisions and these radiopharmacies are consolidated in our financial statements. CTI Solutions accounted for the Houston joint venture

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under the equity method in the financial statements for the three months ended December 31, 2002 in accordance with EITF 96-16. In March 2003, an amendment to the joint venture agreement was adopted that removed the participating rights of the minority partner. Accordingly, CTI Solutions is now deemed to have control over the significant operating decisions of the joint venture and the entity is consolidated in the Company’s financial statements effective March 1, 2003.

     In cases where the minority shareholder is deemed to have “veto rights” or has equal representation on the board of directors, the Company accounts for these investments using the equity method as the Company does not have control over significant operating decisions. The Company has invested in four radiopharmacies that are accounted for under the equity method. The Company is assessing the potential impact of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. See the Recent Accounting Pronouncements section of this note below.

     Revenue Recognition — The Company records revenues in accordance with the guidance of the SEC’s Staff Accounting Bulletin No. 104 (SAB 104), which supercedes SAB 101 in order to encompass EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21). Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the contract price is fixed or determinable, and collectibility is reasonably assured. No right of return privileges are granted to customers after shipment.

     The Company accounts for sales of scanning equipment and related installation and associated training services as multiple-element arrangements. The Company recognizes revenue for the elements separately as (i) the sales of the equipment, installation and training services represent separate earnings processes, (ii) revenue is allocated among the elements based on the fair value of the elements and (iii) installation and associated training are not deemed essential to the functionality of the equipment (as other companies are available to provide the installation and associated training services and are sometimes employed by CTI to do so). The Company determines the value of the equipment and installation and training services based on sales of the equipment both with and without installation and training. The Company derives its revenues from sales of scanners, calibration sources, spare parts, detector materials, cyclotrons, radiopharmaceuticals and the provision of services on equipment sold, including site planning and installation, repair and maintenance, training, technical support and assistance with licensing. Revenues derived from the sale of scanners, calibration sources, spare parts, and detector materials are recognized upon either shipment or arrival at destination depending on shipment terms.

     For arrangements with multiple deliverables, such as scanner and cyclotron sales, we recognize product revenue by allocating the revenue to each deliverable based on the fair value of each deliverable in accordance with EITF 00-21. EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Due to our adoption of the provisions of EITF 00-21 the Company can now, for cyclotron arrangements entered into after July 1, 2003, separate cyclotron equipment from cyclotron installation services and recognize revenue for cyclotron equipment upon shipment and for cyclotron installation as services are performed. Prior to the implementation of EITF 00-21, the Company recognized revenue for all cyclotron sales in accordance with SAB 101 and did not recognize revenue for cyclotron system sales until installation was complete and customer acceptance was obtained, as functionality was deemed essential for cyclotrons. In accordance with transition provisions of EITF 00-21, revenue recognition for any cyclotron system sales, for which contracts were entered into prior to July 1, 2003 will continue to be accounted for under SAB 101 and revenue recognition will be deferred until installation is complete and customer acceptance is obtained.

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

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

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

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

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

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

     Other Assets – Other assets include purchased technology arising from the Mirada Solutions Limited acquisition, long-term lease receivables, precious metals utilized in the production of detector materials, other long-term receivables and investments accounted for under the equity method. Purchased technology, patents, and trademarks are presented at cost, net of accumulated amortization. Intangible assets with finite lives are amortized over their estimated useful lives of 5 to 10 years using the straight-line method. Amortization expense for the three months ended December 31, 2003 was $344 and has been recorded in cost of sales. There was no amortization expense during the three months ended December 31, 2002.

Recent Accounting Pronouncements

     Consolidation of Variable Interest Entities - On January 17, 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. FIN 46 expands upon and strengthens existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is any legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. Previously, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. FIN 46 will be effective with the first interim reporting period ending after March 15, 2004. The Company is continuing to assess the impact of the application of FIN 46.

     Revenue Recognition – On December 17, 2003, the Staff of the Securities and Exchange Commission (SEC) issued SAB 104, Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element arrangements, superceded as a result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables” (EITF 00-21). The guidance contained in SAB 104 reflects the issuance of EITF 00-21, but the revenue recognition principles remaining largely unchanged. As the Company has already incorporated EITF 00-21 and SAB 101, into its revenue recognition policies, the adoption of SAB 104 did not have a significant impact on the Company’s financial statements.

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3. Inventories

Inventories consist of the following:

     Cyclotrons that have been delivered but not yet accepted by customers are included in inventories as finished goods in the condensed consolidated balance sheets at December 31, 2003 and September 30, 2003 in the amount of $1,944 and $1,346, respectively.

4. Property and Equipment

     Property and equipment consist of the following:

     Depreciation expense for the three months ended December 31, 2003 and 2002 was $3,585 and $2,517, respectively.

5. Commitments and Contingencies

     CTI guarantees lease obligations for radiopharmacy facilities and equipment on behalf of unconsolidated investees in the maximum aggregate amount of $898 at December 31, 2003. The guarantees are not collaterized by any assets and are without recourse. No liability has been recorded for these lease obligations which expire through 2009 as these guarantees were entered into prior to the effective date of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45).

     In August 2003, the Company also guaranteed a debt obligation related to a cyclotron and radiopharmacy project for an international distributor in the maximum aggregate amount of 5.3 million Euros (or approximately $6.6 million at December 31, 2003). The debt obligation and the guarantee expire in July 2009. In the event a claim is made under this guarantee, the Company has the right to acquire the facility and all related customer contracts and would operate the facility as a PETNET radiopharmacy. The Company has recorded a liability of $150 for this guarantee to reflect the estimated fair value of the Company’s obligation in accordance with FIN 45.

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     The Company has a financing program arrangement with De Lage Landen Financial Services, Inc. (DLL). The program provides flexible lease financing for the full range of PET and PET/CT scanners and other products and services sold by CTI. In connection with this program a credit reserve pool was established whereby the Company provides a guarantee to DLL for 9.9% on the first $25 million of transactions and 5.0% once $50 million in transactions is achieved, of the principal balance of all leases DLL executes on the Company’s behalf. At December 31, 2003, the Company had recorded a reserve of $148 for this guarantee to reflect the estimated fair value of the Company’s obligation, after recovery and resale of the underlying equipment, in accordance with FIN 45.

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

     In May 2002, Cox Nuclear Pharmacy Inc. & Accuscan LLC filed an action against CTI, PETNET and an employee of PETNET in the United States District Court for the Southern District of Alabama, Southern Division, civil action no. 02-cv-0321-CG-C. The plaintiffs 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 9, 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 the employee from using General Electric’s confidential information and trade secrets, and enjoining us from disclosing or using any confidential information or trade secrets gained by the employee during his employment at General Electric. We have denied liability and intend to vigorously defend this suit; however, given the uncertainties inherent in the litigation process, we are unable to predict the ultimate outcome of this suit.

     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 of GE’s claims on December 15, 2003. Given the uncertainties inherent in the litigation process, we are unable to predict the ultimate outcome of this suit; however, we intend to deny the allegations and vigorously defend this action.

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     On January 30, 2004, the University of Pittsburgh (“Pitt”) filed suit in the Western District of Pennsylvania against Dr. David Townsend, Dr. Ronald Nutt, CTI and CPS alleging that Pitt has an ownership interest in the intellectual property associated with the PET/CT system manufactured and sold by CPS. Under a variety of causes of action, the relief sought by Pitt in the complaint is a declaration of Pitt’s ownership rights, injunctive relief against disclosure and transfer of the intellectual property, actual and punitive damages, and attorney’s fees. Based on the results of the Company’s investigation, which is continuing, the Company intends to vigorously defend against Pitt’s claim of an ownership interest in these patents or in any other intellectual property used in the PET/CT system manufactured and sold by CPS, or that Pitt has any right to a share of the profits earned from the sale of PET/CT systems. The Company has not been served with a copy of the complaint and has therefore not yet responded. We deny liability and intend to vigorously defend this suit; however, given the uncertainties inherent in the litigation process, we are unable to predict the ultimate outcome of this suit.

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

6. Long-Term Debt

     The Company has a $125,000 syndicated revolving credit facility (the Syndicated Facility) with a group of banks. Borrowing under the Syndicated Facility is collateralized by all property and interests in property; provided, however, that all real property of CTI as of March 14, 2002 is excluded; and provided further that the property and interests of CPS are limited to the inventory and accounts receivable and all proceeds therefrom of CPS. Interest is at LIBOR plus 0.75% to 1.75% or, at the Company’s option, the lender’s base rate plus 0.00% to 0.75%, payable monthly (2.42% at December 31, 2003). The Syndicated Facility matures on October 15, 2005 and contains certain restrictive covenants, which, among other things, require minimum tangible net worth, funded debt, and debt service ratios; impose limitations on other indebtedness and liens; and, restrict investments, disposals of assets and dividend payments. There was no outstanding balance under the Syndicated Facility at December 31, 2003.

     Industrial Revenue Bonds — In 1988 the Company entered into an agreement with the Industrial Development Board of Blount County, Tennessee (the Board) relating to the issue of Industrial Development Revenue Bonds (the Series 1988 Bonds) by the Board in the aggregate principal amount of $5,000 for the purpose of lending proceeds from the Bonds to the Company. Such proceeds were restricted to use in the acquisition, construction, improvement, and equipping of a manufacturing plant in Blount County, Tennessee. The remaining $4,000 balance of the Series 1988 Bonds is supported by an irrevocable letter of credit agreement that expires October 15, 2005. The Series 1988 Bonds are due in August 2008.

     On August 1, 2000 the Company entered into an agreement with the Board relating to the issue of Industrial Development Revenue Bonds (the Series 2000 Bonds) by the Board in the aggregate principal amount of $3,000 for the purpose of lending proceeds from the Series 2000 Bonds to the Company. Such proceeds are restricted to use in the acquisition, construction, improvement and equipping of the Company’s manufacturing plant in Blount County, Tennessee. At December 31, 2003, the remaining balance of the Series 2000 Bonds was $1,600 and is supported by an irrevocable letter of credit agreement that expires October 15, 2005. The Series 2000 Bonds are due in August 2010. In May 2002, the Company redeemed all outstanding tax-exempt bonds and reissued taxable bonds for the purpose of terminating federal government limitations on aggregate capital expenditures.

     CTI is required to repay 10.0% of the outstanding debt annually, for both series. Both bond series bear interest at variable rates, which change from time to time as set by the remarketing agents for the bonds, in order to remarket both bond series in a secondary market (interest rates were from 1.30% to 1.40% at December 31, 2003, respectively).

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     Notes Payable — In August 2003 in conjunction with the acquisition of Mirada Solutions Limited, we assumed a $365 note payable to a bank and issued $3,188 of unsecured loan notes. Interest on the bank note is at the bank base rate plus 1.25% (5.0% at December 31, 2003) and the outstanding balance was $371 at December 31, 2003. For the unsecured loan notes issued during the acquisition, the note holder can request to be paid the lower of $15 or their outstanding note balance on April 30, 2004 along with any accrued interest to date. The remaining balance and outstanding interest on the unsecured loan notes will then be paid in full by April 30, 2005. Interest on the unsecured loan notes is fixed at 1.50%.

     In 2003, CTI, through its subsidiary CPS, entered into a mortgage loan to purchase additional manufacturing space, which had previously been leased. The Company is required to make principal and interest payments totaling $78 per year through 2008, with a balloon payment upon maturity. The debt bears interest at a fixed rate of 4%. The outstanding balance on this mortgage loan was $862.

7. Income Taxes

     The Company files a consolidated U.S. federal income tax return that includes CTI, Detector Materials and the domestic subsidiaries of the CTI Solutions segment. CPS files a separate U.S. federal income tax return and all foreign subsidiaries file returns in their country of incorporation. The Company’s effective tax rate on income before taxes and minority interest differs from the federal statutory rate as follows:

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8. Stock Options and Restricted Stock

Incentive Stock Option Plans

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

     The following table summarizes information about incentive stock options under both plans at December 31, 2003:

     ⁽¹⁾ Weighted average contractual life remaining in years.

     ⁽²⁾ Weighted average exercise price.

Non-qualified Options

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

     The following table summarizes information about non-qualified stock options at December 31, 2003:

     ⁽¹⁾ Weighted average contractual life remaining in years.

     ⁽²⁾ Weighted average exercise price.

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9. Related Party Transactions

     From 1987 through April 2001 Siemens was the exclusive distributor of scanners manufactured by CPS. In April 2001 CPS implemented a new multiple distributor strategy. The current distribution agreement with Siemens, which was effective March 1, 2002, has an initial term of five years with a one-year renewal period. The agreement is cancelable with three years notice upon the expiration of the then current term. Transfer prices are set annually and vary with product type and annual shipment volume. Sales are F.O.B. factory. Siemens is provided a warranty discount to cover their cost of parts during the first twelve months of usage. Siemens is responsible for all site planning, installation and customer training. The Company’s sales through and to Siemens were $33,471 and $25,254, during the three month periods ended December 31, 2003 and 2002, respectively. Accounts receivable from Siemens totaled $37,090 and $42,430, at December 31, 2003 and September 30, 2003, respectively. Also, customer advances from Siemens totaled $887 and $326, at December 31, 2003 and September 30, 2003, respectively.

     Under the terms of an agreement with Siemens (the Siemens Agreement), Siemens has the right to purchase, and CTI has the right to require Siemens to purchase, an additional 30.1% of CPS. The exercise of this put/call is contingent upon cumulative unit sales of ECAT® scanners reaching a defined target level. At December 31, 2003 the cumulative total number of units sold by CPS was 729. By September 30, 2004, CPS would need to have sold a cumulative total of 1,055 units to achieve the required cumulative sales level for the put/call to be exercisable, with such cumulative unit sales requirement increasing by 74 units each year thereafter. Upon exercise of the put/call, the Siemens Agreement provides for the purchase price to be established through an independent third party valuation process if the parties are unable to agree upon a price. Once CTI is notified of Siemens’ intent to purchase the additional interest, CTI has the right to defer the Siemens purchase for one year. CTI does not expect this target level to be reached before the second half of fiscal year 2005.

     The Company has a distribution agreement with Concorde Microsystems, Inc (Concorde), a company partially owned and operated by children of CTI’s President and Chief Executive Officer, who is also a director and major stockholder of CTI. Under the terms of the agreement, PETNET was granted an exclusive, royalty-free license to distribute Concorde products throughout the continental United States and Canada. The Company is responsible for sales, marketing and education activities while Concorde is responsible for all product warranty, installation, training, service and technical support. During the three months ended December 31, 2003, total sales and cost of sales of Concorde products under this distribution agreement were $1,377 and $1,268, respectively. There were no transactions under this agreement for the quarter ended December 31, 2002.

10. Segments

     The Company operates in three reportable business segments based on differences in products and services: CPS, Detector Materials, and CTI Solutions. CPS designs, manufactures and markets medical research and scanning equipment. Detector Materials manufactures a scintillation component sold primarily to CPS. CTI Solutions includes the production and distribution of radiopharmaceuticals, and the direct sale and service by CTI of PET scanners, cyclotron systems and other PET related products. CTI Solutions reflects the combination of the former PETNET and CTI Services segments which previously were reported separately. All comparative financial information for fiscal year 2003 has been retroactively reclassified to reflect the new reporting structure.

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

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