United States
Securities and Exchange Commission

Form 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2004

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

For the transition period from ___to ___

Commission File Number: 000-49867

CTI MOLECULAR IMAGING, INC.

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

(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 þ   No o

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

APPLICABLE ONLY TO CORPORATE ISSUERS

As of February 1, 2005, the registrant had outstanding 47,160,278 shares of common stock, par value $0.01.

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

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 December 31, 2004;
	•	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

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

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CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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

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CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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

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CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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 two principal businesses: Clinical Scanner Business and Molecular Biomarker Technologies. Effective October 1, 2004, the Company reorganized its management reporting structure along these lines of business. In accordance with Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company has reevaluated its segment reporting requirements. Management has determined that the Company now has six reporting segments. Primarily, the reporting segment changes resulted in the various product lines of the previously reported CTI Solutions segment being separated into their respective operating segments for determination as to which operating segments met the criteria as reporting segments. As a result, the CTI Solutions reporting segment has been discontinued and disaggregated into the following new reporting segments: Service and Distribution, PETNET, Molecular Technologies, Inc. (MTI), and Molecular Imaging Products.

     CPS manages the development, production and distribution of a full line of Positron Emission Tomography (PET) scanners. Detector Materials develops and manufactures detector materials used in PET scanners. Service and Distribution includes CTI’s division that manufactures and sells calibration sources; CTI’s domestic scanner service division; CTI’s division that provides sales and marketing services to Siemens; and CTI’s division that distributes and installs our remaining backlog of direct distribution orders for PET scanners manufactured by CPS. PETNET develops, produces and distributes radiopharmaceuticals. MTI manages the research and development of new biomarker products. Molecular Imaging Products includes the production, direct sale and service of cyclotron systems, microPET® and microCAT® animal scanners, and Mirada image analysis tools.

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 14, 2004. Information in the accompanying condensed consolidated financial statements and notes to the financial statements for the three month periods ended December 31, 2004 and 2003 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, 2004 are not necessarily indicative of the results that may be expected for the year ending September 30, 2005 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 in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46(R), Consolidation of Variable Interest Entities (FIN 46(R)), SFAS No. 94, Consolidation of All Majority-Owned Subsidiaries (SFAS 94), and Accounting Principles Board (APB) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB 18) and, where appropriate, evaluates its and the minority shareholders’ participating rights in accordance with Emerging Issue Task Force (EITF) Issue 96-16,

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Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights (EITF 96-16) to determine whether consolidation or equity method accounting is appropriate in each case.

     The Company evaluated FIN 46(R)’s effects on its investments during the second quarter of fiscal year 2004. In conjunction with this evaluation, the Company identified one of its consolidated investments as a variable interest entity as defined by FIN 46(R). However, the evaluation of FIN 46(R) did not have a significant impact on the Company’s consolidated financial statements since the Company has the majority voting interest and is also identified as the primary beneficiary of the variable interest entity and therefore is not required to make changes to the entities included in the consolidated financial statements for this reporting period. As required by FIN 46(R), the Company continues to monitor its investments in both consolidated and unconsolidated entities for events that may occur which would require the Company to reevaluate whether any of these investments qualifies as a variable interest entity. The evaluation of FIN 46(R) did not result in changes in the application of previously issued generally accepted accounting principles, SFAS 94 and APB 18, to the Company’s investments.

     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.

     Through PETNET, we own 90.0% and 51.0% interests in radiopharmacies in Denver and Houston, respectively. Under the terms of the Denver and Houston radiopharmacy operating agreements, PETNET has control over all significant operating decisions and these radiopharmacies are consolidated in our financial statements.

     Where appropriate, the Company evaluates its and the minority interest shareholders’ participating rights in accordance with EITF 96-16 to determine whether consolidation or equity method accounting is appropriate in each case. 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 three radiopharmacies that are accounted for under the equity method. For the entities not previously included in the consolidated financial statements, the evaluation of FIN 46(R) resulted in the Company continuing to apply previously issued generally accepted accounting principles to the respective investments and continuing to account for these entities under the equity method.

     Revenue Recognition —The Company derives its revenues from product sales, services and software licensing. Product sales include sales of scanners, detector materials, calibration sources, spare parts, radiopharmaceuticals, and cyclotrons. Services include; site planning, installation, preventive maintenance and technical support, repair, training, and assistance with licensing. Software includes licensing medical image analysis applications. The Company also recognizes as revenue reimbursements for certain sales and marketing services as such services are provided to Siemens as the Company is the primary obligor for the expenses incurred in providing these services. Revenue from product sales is recognized upon either shipment or arrival at destination depending on shipment terms. Revenue from services is recognized as the services are performed. For both products and services, revenue is recognized as described as long as persuasive evidence of an arrangement exists, the contract price is fixed or determinable, and collectibility is reasonably assured as required by the SEC’s Staff Accounting Bulletin No. 104 (SAB 104). No right of return privileges are granted to customers after shipment. Equipment maintenance service contracts are typically more than one year 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 services. The Company’s product sales contracts typically require customer payments in advance of revenue recognition. These deposit amounts are reflected as customer advances when received and later recognized as revenue as the Company fulfills its obligations under the respective contracts.

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     For arrangements with multiple deliverables, such as scanner and cyclotron sales, we recognize product revenue by allocating the revenue based on the fair value of each deliverable in accordance with EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21) and SAB 104, and recognize revenue for equipment upon delivery and for installation and other services as performed. The Company determines the value of the equipment, installation and training services based on sales of the equipment both with and without installation and training.

     Revenues derived from our software license arrangements are recognized in accordance with Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,” and SOP 98-9, “Modifications of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions.” Our software licenses generally are sold with training and installation services. Accordingly, as these services are included in our software license fees, revenue is recognized at the time of delivery. These services are usually provided within less than a year of delivery; the costs of providing such services are insignificant. No other services are considered essential to the functionality of the software. Revenue is recognized as described provided that evidence of an arrangement exists, collection of our fee is considered probable and the fee is fixed or determinable.

     Stock-Based Compensation – SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FASB Statement No. 123 (SFAS 148), amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), to require more prominent disclosure in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

     The Company currently applies APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its stock option plans. Under APB 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of the Company’s stock and the exercise price. 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:

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     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:

     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, 2004 and 2003 because including them would have had an antidilutive effect:

     Other Assets – Other assets include purchased technology and trademarks arising from the Mirada Solutions Limited (Mirada) and Concorde Microsystems, Inc. (CMSI) acquisitions, precious metals utilized in the production of detector materials, other long-term receivables and investments accounted for under the equity method. Purchased technology, patents, trademarks are presented at cost, net of accumulated amortization. Intangible assets with finite lives are amortized over their estimated useful lives of 5 to 11 years using the straight-line method. Amortization of other assets for the three months ended December 31, 2004 and 2003 was $790 and $399, respectively.

Recent Accounting Pronouncements

     Share-Based Payment - In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB 25, and generally would require instead that such transactions be accounted for using a fair-value-based method. The Company is currently evaluating SFAS 123R to determine which fair-value-

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based model and transitional provision it will follow upon adoption. The options for transition methods as prescribed in SFAS 123R include either the modified prospective or the modified retrospective methods. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock as the requisite service is rendered beginning with the first quarter of adoption, while the modified retrospective method would record compensation expense for stock options and restricted stock beginning with the first period restated. Under the modified retrospective method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. SFAS 123R will be effective for the Company beginning in its fourth quarter of fiscal 2005. Although the Company will continue to evaluate the application of SFAS 123R, management expects adoption of this standard to have a material impact on its results of operations.

     Inventory Costs – On November 24, 2004, the FASB issued SFAS No. 151, Inventory Costs- an amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 amends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter 4, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that these costs be recognized as current period charges regardless of whether they are abnormal. In addition, SFAS 151 requires that allocation of fixed production overheads to the costs of manufacturing be based on the normal capacity of the production facilities. SFAS 151 shall be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not expect SFAS 151 to have a material effect on its financial statements.

     Exchange of Nonmonetary Assets – In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No. 29 (SFAS 153). SFAS 153 addresses the remeasurement of exchanges of nonmonetary assets. This statement eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets within APB Opinion No. 29, and replaces it with an exception for exchanges that do not have commercial substance. The provisions of SFAS 153 shall be effective for nonmonetary transactions occurring in fiscal periods beginning after June 15, 2005. The Company will apply the provisions of SFAS 153 if we exchange nonmonetary assets.

3. Inventories

Inventories consist of the following:

4. Property and Equipment

     Property and equipment consist of the following:

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     Depreciation expense for the three months ended December 31, 2004 and 2003 was $4,777 and $3,585, respectively.

5. Commitments and Contingencies

     Guarantees - The Company guarantees lease obligations for radiopharmacy facilities and equipment on behalf of unconsolidated investees in the maximum aggregate amount of $225 at December 31, 2004. No liability has been recorded for these lease obligations which expire through 2009. The guarantees are not collateralized by any assets and are without recourse.

     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 €5,256 (or approximately $7,131). 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. At December 31, 2004, the Company had recorded a liability of $300 for this guarantee to reflect the estimated fair value of the Company’s obligation in accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45).

     The Company has a financing program arrangement with De Lage Landen Financial Services, Inc. (DLL). The program provides flexible lease financing to Service and Distribution’s customers for the full range of PET and PET/CT scanners and other products and services sold by the Company through Service and Distribution. In connection with this program a credit reserve pool was established whereby the Company provided a guarantee to DLL for 9.9% on the first $25,000 of transactions and 5.0% thereafter, of the principal balance of all leases DLL executes on behalf of Service and Distribution’s customers. At December 31, 2004 the Company had recorded a reserve of $280 to reflect the estimated fair value of the Company’s obligation for this guarantee after recovery and resale of the underlying equipment in accordance with FIN 45.

     Warranties - - The Company provides a parts and labor warranty on certain products it manufactures, 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:

     Litigation - - On January 30, 2004, the University of Pittsburgh (Pitt) filed suit in the U.S. Western District of Pennsylvania, Civil Action No. 04-0127, 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. On June 30, 2004, the District Court for the Western District of Pennsylvania entered an order transferring the case to the District Court for the Eastern District of Tennessee. On December 13, 2004, the district court judge issued an order dismissing two of Pitt’s copyright claims asserted in its

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complaint. A trial date of May 1, 2006 has been scheduled with the District Court. The Company denies liability as to Pitt’s remaining claims, and intends to vigorously defend this suit; however, given the uncertainties inherent in the litigation process, the Company is unable to predict the ultimate outcome of this suit.

     On October 8, 2004, CPS received a letter from the U.S. Environmental Protection Agency (EPA) requesting information on a Superfund site operated by a former supplier. Based on CPS’ investigation, it appears that the sole nature of CPS’ dealing with the supplier was strictly for the acquisition of supplies and not the provision of waste products or by-products by or on behalf of CPS. No legal action has been initiated or threatened by the EPA against CPS at present and we have no basis at this time to believe that any formal legal claim will be brought by the EPA.

     The Company is 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, the Company does 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 there from 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 (3.56% at December 31, 2004). 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. As of December 31, 2004 no balance was outstanding under the credit agreement, and after deducting $6,605 in outstanding letters of credit, $118,395 was available to the Company.

     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 February 7, 2006. 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, 2004, the remaining balance of the Series 2000 Bonds was $1,600 and is supported by an irrevocable letter of credit agreement that expires February 7, 2006. The Series 2000 Bonds are due in August 2010.

     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 2.13% and 2.45% at December 31, 2004).

     In August 2003 in conjunction with the acquisition of Mirada, we assumed a $365 bank note and issued $3,188 of unsecured loan notes. The bank note was repaid in March 2004. For the unsecured loan notes issued during the acquisition, the remaining balance of $692 and any outstanding interest is due on 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 $818 at December 31, 2004.

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7. Income Taxes

     The Company files a consolidated U.S. federal income tax return that includes all of its wholly owned domestic subsidiaries. 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:

8. Stock Options and Restricted Stock

Incentive Stock Option Plans

     Since 1998 the Company has had an incentive stock option plan for officers and key employees with the latest plan being adopted in 2002. Options are generally exercisable in installments of 25% per year from the grant date and expire after five to ten years. At December 31, 2004, options for 1,498,558 shares of the Company’s common stock were available for granting. The following table summarizes information about incentive stock options at December 31, 2004:

	(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 and expire after five to ten years.

     The following table summarizes information about non-qualified stock options at December 31, 2004:

	(1) Weighted average contractual life remaining in years. (2) Weighted average exercise price.

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Stock-Based Compensation

     In October 2004, the Company issued 60,000 restricted shares of common stock at a price of $8.16 to a senior executive. In connection with these restricted common shares, the Company recorded unearned compensation of $490. The Company is amortizing the unearned compensation balance to stock-based compensation expense over a six-month vesting period during which the restrictions expire. The Company amortized $245 to stock-based compensation expense for the three months ended December 31, 2004. In addition, the Company accelerated the vesting schedule of 128,000 options previously issued to this senior executive. The options were revalued to $8.16, the price on the day of remeasurement. The Company recorded unearned compensation for the excess of estimated fair value at the remeasurement date over the previously calculated fair value of the options, totaling $266 and amortized this amount to stock-based compensation expense during the three months ended December 31, 2004.

9. Related Party Transactions

     Siemens is the primary distributor of scanners manufactured by CPS. 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, recorded as a reduction of sales price, 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 to Siemens were $65,411 and $33,471, during the three month periods ended December 31, 2004 and 2003, respectively. Accounts receivable from Siemens totaled $56,077 and $34,231, at December 31, 2004 and September 30, 2004, respectively. Accounts payable to Siemens totaled $3,667 and $1,367, at December 31, 2004 and September 30, 2004, respectively. Also, customer advances from Siemens totaled $1,685 and $1,284, at December 31, 2004 and September 30, 2004, respectively.

     Effective May 1, 2004, CTI and CPS entered into a Sales Agency and Services Agreement with Siemens (the Agency Agreement), pursuant to which Siemens appointed CTI as Siemens’ non-exclusive sales representative to solicit purchases of CPS-manufactured PET and PET/CT scanners throughout the United States, on terms and conditions and at prices determined by Siemens and subject to acceptance by Siemens. CPS products sold by CTI as Siemens’ sales representative are marketed and sold under the Siemens brand. In connection with this arrangement, Siemens will reimburse CTI for all directly related sales and marketing expenses, up to $10.0 million annually. During the three month period ended December 31, 2004, CTI recorded $2.0 million of revenue related to the reimbursement of sales and marketing expenses.

     Service contracts entered into in connection with scanner sales in the United States after May 1, 2004 will be divided equally between CTI and Siemens in terms of revenue. Siemens and CTI remain free to independently pursue sales of service contracts to the installed base of CPS scanner customers.

     During the two-year term of the Agency Agreement, CTI agreed to cease its sales and service of PET and PET/CT scanners in international markets, except in South Korea and Japan. All existing scanner service contracts in international markets other than South Korea and Japan were assigned to Siemens. During the term of the Agency Agreement, CTI has agreed not to enter or re-enter any international market to sell or service PET or PET/CT scanners, except that CTI may continue to pursue its existing business in South Korea and may retain its existing distribution agreement in Japan. In exchange for the assignment of the international service contracts, covenants not to compete in the United States and international markets other than South Korea and Japan, certain price reductions for detector materials including on international scanner sales, and as compensation for the cost of closing certain international operations, Siemens paid CTI $2.2 million. CTI recognized $1.1 million as revenue during the year ended September 30, 2004, in association with the assignment of international service contracts. The remaining amount is being amortized over the two-year term of the agreement concurrent with our LSO price reduction and non-compete commitments.

     Under the Agency Agreement, Siemens serves as CTI’s non-exclusive representative to offer for sale other products manufactured by CTI to Siemens’ customers. Subject to the expiration or termination of any existing agreements Siemens agreed to offer exclusively CTI’s cyclotrons, radiopharmaceuticals and calibration sources for sale to Siemens’ customers.

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     The parties also agreed to certain changes in transfer prices charged to and received from CPS. Siemens and CTI have reduced the transfer prices for CT components and LSO detector materials, respectively, sold to CPS. These price reductions are being passed on, dollar-for-dollar, in the form of lower transfer prices on scanners sold by CPS to Siemens. CPS agreed to a second round of transfer price reductions on scanners sold to Siemens, which are expected to become effective during the second quarter of fiscal year 2005.

     The initial term of the Agency Agreement is two years commencing May 1, 2004, and the term will be extended automatically for additional one-year periods unless either party provides written notice, as required, of its election not to renew. In the event the Agency Agreement is terminated or not renewed by Siemens for any reason, CTI has the right to resume distribution of PET and PET/CT scanners in competition with Siemens. The Agency Agreement also provides that CTI can terminate this agreement under certain specified circumstances, including the event that certain total unit sales thresholds for PET and PET/CT scanners are not met for a period of two consecutive fiscal quarters.

     Siemens also executed an agreement with Mirada, under which Siemens pays Mirada a fee to install Mirada’s image-fusion software on every workstation shipped worldwide with a Siemens-branded PET or PET/CT scanner.

     Under the terms of an agreement with Siemens (the Siemens Agreement), Siemens shall have the right to purchase, or CTI shall have the right to require Siemens to purchase, an additional 30.1% of CPS. The exercise of this put/call is contingent upon cumulative unit sales of ECAT^® scanners reaching a defined target level. At December 31, 2004 the cumulative total number of units sold by CPS was 889. By the end of 2005, CPS would need to have sold a cumulative total of 1,129 units to achieve the required cumulative sales level for the put/call to be exercisable, with such cumulative unit sales requirement increasing by 74 units each year thereafter. Upon exercise of the put/call, the Siemens Agreement provides for the purchase price to be established through an independent third party valuation process if the parties are unable to agree upon a price. Once CTI is notified of Siemens’ intent to purchase the additional interest, CTI shall have the right to defer the Siemens purchase for one year. CTI does not expect this target level to be reached before the second half of fiscal year 2006. Siemens cannot exercise its option until the end of the fiscal year in which this target level is reached.

     Prior to the Company’s acquisition of the business and assets of CMSI in June 2004, the Company had four agreements with CMSI, a company partially owned and operated by two children of CTI’s President and Chief Executive Officer, who is also a director and major shareholder of CTI.

     In September 2002, the Company entered into an agreement to distribute CMSI products throughout the continental United States and Canada. CMSI retained the rights to, and sold products directly to all international markets other than Canada. During the three months ended December 31, 2003, total sales and cost of sales of products purchased from CMSI and resold under this distribution agreement were $1,377 and $1,268, respectively. In connection with the acquisition of CMSI’s business and assets, this distribution agreement was terminated.

     On September 5, 2002 CTI entered into an LSO Supply Agreement with CMSI pursuant to which CTI agreed to provide CMSI with LSO. In this agreement, CTI agreed not to sell LSO to another third party engaged in the development or manufacture of PET scanners for use in animal applications. During the three months ended December 31, 2003 and prior to the acquisition of CMSI, LSO sales to CMSI were $25. In connection with the acquisition of CMSI’s business and assets, this LSO Supply Agreement was terminated.

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10. Segments

     The Company’s products and services can be broadly classified into two principal businesses: Clinical Scanner Business and Molecular Biomarker Technologies. Effective October 1, 2004, the Company reorganized its reporting structure to align with organizational changes made as of that date. Within these two businesses we have six reporting segments. 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. Service and Distribution includes the direct sale and service of PET scanners and related products as well as sales and marketing services provided to Siemens. PETNET develops, produces and distributes radiopharmaceuticals. MTI manages the research and development of new biomarker products. Molecular Imaging Products includes the production, direct sale and service of cyclotron systems, microPET® and microCAT® animal scanners, and Mirada image analysis tools. All comparative financial information for the three months ended December 31, 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 & Eliminations”. The Company evaluates the performance of its segments based on net income (loss). The Company’s business is conducted principally in the U.S.; however, the Company does have foreign operations for which identifiable assets are immaterial.

     The following table summarizes information about net income (loss) and segment assets used by the chief operating decision maker of the Company in making decisions regarding allocation of assets and resources as of and for the three month periods ended December 31, 2004 and 2003:

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Sales were distributed to the following locations:

11. Stockholder Protection Rights

     During 2002 the Company’s Board of Directors adopted a stockholder protection rights agreement and declared a dividend of one Right for each share of Common Stock held of record on the closing date of the initial public offering. The Rights, which do not have any voting rights, are generally not exercisable until 10 days after an announcement by the Company that a person has acquired at least 15% of the Company’s Common Stock. Each Right, should it become exercisable, will entitle the owner to buy one ten-thousandth of a share of Series C Junior Participating Preferred Stock at an exercise price of $130. The Rights may be terminated without payment by the Company at any time prior to the date that is ten business days after the acquisition of 15% or more of the Company’s Common Stock by a person or group.

     In the event the Rights become exercisable as a result of the acquisition of at least 15% of the Company’s Common Stock, each Right will entitle the owner, other than the acquiring person, to buy at the Right’s then current exercise price a number of shares of Common Stock with a market value equal to twice the exercise price. In addition, unless the acquiring person owns more than 50% of the outstanding shares of Common Stock, the Board of Directors may elect to exchange all outstanding Rights (other than those owned by such acquiring person or affiliates thereof) at an exchange ratio of one share of Common Stock per Right. The Rights expire on June 1, 2012 unless earlier terminated by the Board. As a result of the adoption of the Shareholders’ Rights Plan, 50,000 shares of authorized preferred stock have been reserved and designated as Series C Junior Participating Preferred Stock.

12. Business Acquisitions

     On November 2, 2004, the Company acquired 100% of the capital stock of ImTek, Inc. (ImTek). ImTek designs and manufactures the microCAT® brand of micro-CT scanners, which are used in preclinical applications of small animal imaging. The balance sheet and results of operations of ImTek and are included in our consolidated financial statements as part of the Molecular Imaging Products segment effective November 2, 2004. The acquisition augments the Company’s expanding capabilities to serve the pharmaceutical research market.

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     The aggregate purchase price was $3,675 in cash. The purchase price allocation is subject to refinement as additional transaction related costs may be incurred. Under the purchase agreement, the Company may be required to make additional payments if certain separate and defined goals are exceeded in 2005 and 2006 for either gross profit or units delivered. If additional payments are required the Company will adjust goodwill at that time. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

     The acquired trademarks and goodwill are considered to have an indefinite life and no amortization will be recorded against the asset. However, the trademarks and goodwill will be reviewed for impairment on an annual basis. The goodwill is not expected to be deductible for tax purposes. No pro forma disclosures have been included in these financial statements as ImTek was not significant to the consolidated financial statements taken as a whole.

     The changes in the carrying value of goodwill for the period ended December 31, 2004 are as follows:

     The “Corporate & Eliminations” column primarily reflects the goodwill arising from the acquisitions of PETNET and Mirada that was not pushed down for segment reporting. Of the $47,385 total for Molecular Imaging Products and Corporate and Eliminations, $11,272 relates to PETNET, $12,485 relates to Mirada, $21,582 relates to Concorde, $1,453 relates to ImTek and $593 relates to Detector Materials.

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

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

Overview

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

     Historically, the majority of our consolidated revenues, gross margin and net income have been attributable to CTI PET Systems, Inc., doing business as CPS Innovations (CPS). Our strategy includes plans for growing our other segments over time with a goal of having greater than 50% of our gross revenues being derived from such other segments by 2006, the expected year that Siemens Medical Solutions USA, Inc. (Siemens), a wholly owned subsidiary of Siemens AG, could first announce its intention to exercise its option to purchase a controlling interest in CPS. Upon an exercise by Siemens of the call right, we have a one-time right to defer the sale for a period of one year. This strategy contemplates the following initiatives: (1) expansion of our radiopharmaceutical distribution network to meet market needs; (2) development of new proprietary radiopharmaceuticals; (3) acquisition of complementary PET-related products and services, and (4) growth of our service contract business.

     Late in the third quarter of fiscal year 2004, we observed that the rate of unit growth in the PET and PET/CT market had slowed considerably from historic growth rates; however, our most recent projections for fiscal year 2005 indicate a stable domestic market and escalating growth in international shipments.

     We expect the demand for PET products and services to grow as more indications are approved for reimbursement. However, it is also reasonable to expect reimbursement rates to decline over time, as PET becomes more widely adopted, which could also affect the demand for our products and services.

     Management expects its closer collaboration with Siemens following the execution of the Sales Agency and Services Agreement, effective May 1, 2004, to enable the Company to avoid the substantial costs of the direct scanner distribution business.

Segments

     Effective October 1, 2004 we restructured our organization into two business groupings: the Clinical Scanner Business and Molecular Biomarker Technologies. These two businesses operate in six segments for financial reporting purposes: CPS, Detector Materials, Service and Distribution, PETNET, MTI and Molecular Imaging Products. Service and Distribution, PETNET, MTI, and Molecular Imaging Products represent the breakout of the various components of the former CTI Solutions segment. All comparative financial information for the three months ended December 31, 2003 has been retroactively reclassified to reflect the new reporting structure.

CPS

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

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     From 1987 until April 2001, the products of CPS were distributed exclusively by Siemens. In April 2001 we implemented a multiple distributor strategy for CPS by pursuing additional third-party distributor agreements. In November 2001 CPS added Hitachi Medical Systems America, Inc. as a third-party distributor of its products, and in October 2003 we added Toshiba Medical Systems as a third-party distributor of CPS’ products in Japan. Under these agreements, CPS sets the price to distributors who set their own prices to end customers. CPS does not bear credit risk associated with sales made by the distributor to end customers. Effective May 1, 2004, CTI, CPS and Siemens entered into a new Sales Agency and Service Agreement, as discussed below.

     The scanners manufactured by CPS have historically ranged in customer price from $0.6 million to $2.3 million and offer customers a broad range of scan times, resolution and image quality.

Detector Materials

     Our Detector Materials segment includes our business of developing, manufacturing and selling detector materials for use in PET scanners. The Detector Materials segment has certain exclusive rights to the development and manufacturing of a cerium-doped 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 to develop LSO in order to meet an expected increase in demand for detector materials as the PET market continues to grow.

Service and Distribution

     Service and Distribution includes CTI’s division that manufactures and sells calibration sources; CTI’s domestic scanner service division; CTI’s division that provides sales and marketing services to Siemens; and CTI’s division that distributes and installs the remaining backlog of direct distribution orders for PET scanners manufactured by CPS.

PETNET

     Our PETNET segment consists primarily of our business of developing, manufacturing and distributing positron-emitting radiopharmaceuticals and providing certain PET related services such as reimbursement education, regulatory compliance consulting and marketing assistance.

     We currently operate 42 radiopharmacies in the U.S., one radiopharmacy in the United Kingdom and two radiopharmacies in South Korea. Fourteen 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 45 radiopharmacies which PETNET operates also include three radiopharmacies we do not consolidate, as the Company does not have control over significant operating decisions.

MTI

     MTI is the focal point for our biomarker research and development activities. Through the discovery of new molecular biomarkers of disease and the development of novel molecular synthesis and biological screening platforms, we expect MTI to fuel growth in the diversity of molecular diagnostics used with PET. MTI will augment its initiatives through collaborations with major research institutions as well as major pharmaceutical companies. Through these collaborations, MTI will broaden its technology initiatives in nanotechnologies, microfluidics and systems biology of disease to base its biomarker development on the knowledge of how cells are reprogrammed to gain the properties of disease.

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Molecular Imaging Products

     Our Molecular Imaging Products segment includes CTI’s subsidiaries and divisions that produce, sell, install and service cyclotrons, microPET® and microCAT® animal scanners, and medical image analysis tools.

Components of Revenues and Expenses

Revenues

     Our revenue is derived primarily from sales of PET and PET/CT products and services. Revenues for scanners, detector materials, radiopharmaceuticals, microPET® and microCAT® animal scanners, calibration sources and spare parts are recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable. Delivery is considered to have occurred upon either shipment or arrival at destination depending on shipping terms. Amounts attributable to the installation of scanners are deferred and recognized upon completion of installation. Most of the revenue for detector materials is from sales to CPS and, therefore, is eliminated in consolidation for financial reporting purposes. Effective July 1, 2003, in conjunction with the implementation of Emerging Issues Task Force (EITF) Issue 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (EITF 00-21), revenue for cyclotron systems is recognized upon delivery with amounts attributable to installation of the systems deferred until services are performed. Revenue for service contracts is recognized ratably over the period the service is provided.

Cost of Revenues

     Our scanners, cyclotrons, microPET® and microCAT® animal scanners, detector materials, calibration sources and spare parts are manufactured at facilities in Knoxville and Rockford, Tennessee. Our radiopharmaceuticals are manufactured at 45 radiopharmacies. We employ a network of field service engineers to service our installed base of scanners and cyclotrons.

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

Operating Expenses

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

     Research and Development. Significant investment in research and development has been made, and we believe will continue to be required, to develop new products and enhance existing products to allow us to further penetrate the PET market. These expenses consist primarily of salaries and related personnel expenses; expenditures for prototype materials and supplies; overhead allocated to product development; legal costs associated with filing of patents and regulatory matters; and research grants and consulting fees to various third parties.

Agency Agreement with Siemens

     Effective May 1, 2004, CTI and CPS entered into a Sales Agency and Services Agreement with Siemens (the Agency Agreement), pursuant to which Siemens appointed CTI as Siemens’ non-exclusive sales representative to solicit purchases of CPS-manufactured PET and PET/CT scanners throughout the United States, on terms and conditions and at prices determined by Siemens and subject to acceptance by Siemens. CPS products sold by CTI as Siemens’ sales representative are marketed and sold under the Siemens brand. In connection with this arrangement,

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Siemens will reimburse CTI for all directly related sales and marketing expenses, up to $10.0 million annually. During the three month period ended December 31, 2004, CTI recorded $2.0 million of revenue related to the reimbursement of sales and marketing expenses.

     Service contracts entered into in connection with new or used scanner sales in the United States will be divided equally between CTI and Siemens in terms of revenue. Siemens and CTI remain free to independently pursue sales of service contracts to the installed base of CPS scanner customers.

     During the term of the Agency Agreement, CTI agreed to cease its sales and service of PET and PET/CT scanners in international markets, except in South Korea and Japan. All existing scanner service contracts in international markets other than South Korea and Japan were assigned to Siemens. During the term of the Agency Agreement, CTI has agreed not to enter or re-enter any international market to sell or service PET or PET/CT scanners, except that CTI may continue to pursue its existing business model in South Korea and may retain its existing distribution agreement in Japan. In exchange for the assignment of the international service contracts, the covenant not to compete in the United States and international markets other than South Korea and Japan, certain price reductions for detector materials including on international scanner sales, and as compensation for the cost of closing certain international operations, Siemens paid CTI $2.2 million. CTI recognized $1.1 million as revenue during the year ended September 30, 2004, in association with the assignment of international service contracts. The remaining amount is being amortized over the two-year term of the agreement concurrent with our LSO price reduction and non-compete commitments.

     Under the Agency Agreement, Siemens serves as CTI’s non-exclusive representative to offer for sale products manufactured by CTI and its subsidiaries to Siemens’ customers. Subject to the expiration or termination of any existing agreements for the provision of cyclotrons or radiopharmaceuticals to Siemens’ customers, Siemens agreed to offer exclusively CTI’s cyclotrons, radiopharmaceuticals and calibration sources for sale to Siemens’ customers.

     The parties also agreed to certain changes in transfer prices charged to and received from CPS. Siemens and CTI have reduced the transfer prices for CT components and LSO detector materials, respectively, sold to CPS. These price reductions are being passed on, dollar-for-dollar, in the form of lower transfer prices on scanners sold by CPS to Siemens. CPS agreed to a second round of transfer price reductions on scanners sold to Siemens, which are expected to become effective during the second quarter of fiscal year 2005.

     The initial term of the Agency Agreement is two years commencing May 1, 2004, and the term will be extended automatically for additional one-year periods unless either party provides written notice, as required, of its election not to renew. In the event the Agency Agreement is terminated or not renewed by Siemens for any reason, CTI has the right to resume distribution of PET and PET/CT scanners in competition with Siemens. The Agency Agreement also provides that CTI can terminate this agreement under certain specified circumstances, including the event that certain total unit sales thresholds for PET and PET/CT scanners are not met for a period of two consecutive fiscal quarters.

     Siemens also executed an agreement with Mirada, under which Siemens pays Mirada a fee to install Mirada’s image-fusion software on every workstation shipped worldwide with a Siemens branded PET or PET/CT scanner.

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Results of Operations

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

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

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

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Three Months Ended December 31, 2004 Compared to Three Months Ended December 31, 2003

Revenues

     Net revenues for the three months ended December 31, 2004 were $111.5 million, an increase of $37.4 million, or 50.5%, from $74.1 million for the three months ended December 31, 2003.

Clinical Scanner Business

     CPS. Revenues for the three months ended December 31, 2004 were $67.0 million, an increase of $11.5 million, or 20.7%, from $55.5 million for the three months ended December 31, 2003. The increase in revenues was driven primarily by a 6.8% increase in average scanner sales price due to the continued shift in sales mix from PET to PET/CT scanners. During the three months ended December 31, 2004 and 2003 PET/CT scanner sales were 91.9% and 71.9%, respectively, of total unit sales. In addition, this increase was due to a 15.6% increase in units sold. Intersegment revenues accounted for 8.0% and 32.4% of total CPS revenues for the three months ended December 31, 2004 and 2003, respectively. The decrease in intersegment revenues resulted from reduced sales to Service and Distribution after execution of the Agency Agreement in 2004.

     Detector Materials. Revenues for the three months ended December 31, 2004 were $7.7 million, a decrease of $4.3 million, or 35.8%, from $12.0 million for the three months ended December 31, 2003. The decrease in revenues was primarily attributable to reduced transfer pricing to CPS in accordance with the Agency Agreement executed in May 2004 and CPS’ efforts to reduce inventory levels. Intersegment sales accounted for 100.0% and 99.8% of total detector materials revenues for the three months ended December 31, 2004 and 2003, respectively.

     Service and Distribution. Revenues for the three months ended December 31, 2004 were $17.2 million, an increase of $3.3 million, or 23.7%, from $13.9 million for the three months ended December 31, 2003. The increase in revenues was due to a $2.0 million expense reimbursement under the Agency Agreement and the sale on a direct basis of one additional PET/CT in the first quarter of 2005 over the prior year. Intersegment sales accounted for 27.8% and 11.5% of total Service and Distribution revenues for the three months ended December 31, 2004 and 2003, respectively. The increase in intersegment revenues is due to the sales of two scanners through to our PETNET segment for international projects.

Molecular Biomarker Technologies

     PETNET. Revenues for the three months ended December 31, 2004 were $26.6 million, an increase of $7.1 million, or 36.4%, from $19.5 million for the three months ended December 31, 2003. The increase is primarily attributable to FDG dose shipments increasing by 41.2% in the three months ended December 31, 2004 over the three months ended December 31, 2003; this increase was partially offset by a 12.0% decline in the average revenue per dose during the same time period. The remainder of the increase is attributable to a sale of a PET scanner by our European division of PETNET and revenues from a fee per scan project in Korea (which began after December 31, 2003). Intersegment sales were insignificant for the three months ended December 31, 2004 and 2003.

     MTI. Revenues for the three months ended December 31, 2004 were $0.2 million, compared to none for the three months ended December 31, 2003. The increase is due to MTI beginning the distribution of chemistry production equipment during the three months ended December 31, 2004. Intersegment sales accounted for 24.5% of total MTI revenues for the three months ended December 31, 2004.

     Molecular Imaging Products. Revenues for the three months ended December 31, 2004 were $13.7 million, an increase of $6.5 million, or 90.3%, from $7.2 million for the three months ended December 31, 2003. The increase in revenues was due to the acquisition of the business and assets of Concorde in June 2004, higher average sales prices on cyclotrons sold and increased sales of cyclotron options and spare parts. During each of the three month periods ended December 31, 2004 and 2003 we sold 3 cyclotrons, however the average cyclotron price increased 25.9% as two of the three units sold during the three months ended December 31, 2004 were third party sales compared to only one third party sale during the three months ended December 31, 2003. Sales of microPET® and microCAT® animal scanners were $4.1 million, an increase of $2.7 million, from $1.4 million for the three months ended December 31, 2003. The sales of microPET® animal scanners recognized during the three months ended

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December 31, 2003, were in our role as a distributor of microPET® animal scanners. Intersegment sales accounted for 22.3% and 32.6% of segment revenues for the three months ended December 31, 2004 and 2003, respectively. The decrease in intersegment revenues as a percent of revenues resulted from the increase in third party sales after the acquisition of the business and assets of Concorde and the increase in third party cyclotron sales.

Corporate and Eliminations

     Corporate and Eliminations. Intercompany revenues that were eliminated in consolidation for the three months ended December 31, 2004 were $20.9 million, a decrease of $13.1 million, or 38.5%, from $34.0 million for the three months ended December 31, 2003. The decrease in revenue eliminations was primarily due to decreased sales of PET and PET/CT scanners to Service and Distribution from CPS as well as decreased sales of detector materials to CPS. The decreased sale of detector materials to CPS was attributable to lower prices on detector materials sold to CPS after the implementation of the Agency Agreement and CPS efforts to reduce inventory levels. The decreased sale of PET and PET/CT scanners to Service and Distribution was attributable to our decision to exit the business of direct scanner distribution in conjunction with the execution of the Agency Agreement in fiscal 2004.

Cost of Revenues

     Cost of revenues for the three months ended December 31, 2004 was $69.7 million, an increase of $26.0 million, or 59.5%, from $43.7 million for the three months ended December 31, 2003. Cost of revenues for the three months ended December 31, 2004 was 62.5% of revenues compared to 59.0% for the three months ended December 31, 2003.

Clinical Scanner Business

     CPS. Cost of revenues for the three months ended December 31, 2004 was $43.9 million, an increase of $6.0 million, or 15.8%, from $37.9 million for the three months ended December 31, 2003. Cost of revenues for the three months ended December 31, 2004 decreased to 65.5% of revenues compared to 68.3% of revenues for the three months ended December 31, 2003. The increase in total cost of revenues was due to the increase in PET and PET/CT scanners sold during in the quarter. Cost of revenues decreased as a percentage of revenues due to the LSO and CT price reductions received from the Detector Materials segment and Siemens, respectively, in conjunction with the execution of the Agency Agreement.

     Detector Materials. Cost of revenues for the three months ended December 31, 2004 was $3.8 million, a decrease of $0.6 million, or 13.6%, from $4.4 million for the three months ended December 31, 2003. The decrease in cost of revenues was due to the corresponding decrease in sales to CPS. Cost of revenues for the three months ended December 31, 2004 increased to 49.3% of revenues as compared to 36.7% of revenues for the three months ended December 31, 2003. The increase in cost of revenues as a percentage of revenues was due to the reduction in transfer prices to CPS per the Agency Agreement as well as the sale of higher cost LSO inventories that we purchased as a result of an arbitration order issued during the fourth quarter fiscal year 2004.

     Service and Distribution. Cost of revenues for the three months ended December 31, 2004 was $14.9 million, an increase of $1.8 million, or 13.7%, from $13.1 million for the three months ended December 31, 2003. Cost of revenues for the three months ended December 31, 2004 decreased to 86.6% of revenues compared to 94.2% of revenues for the three months ended December 31, 2003. The increase in total cost of revenues was due to the increase in direct distribution sales of PET and PET/CT scanners. Cost of revenues decreased as a percentage of revenues primarily due to $2.0 in revenue recognized for sales and marketing services provided to Siemens for which the related costs are classified as operating expenses, offset by lower margins on direct distribution sales of PET and PET/CT scanners.

Molecular Biomarker Technologies

     PETNET. Cost of revenues for the three months ended December 31, 2004 was $19.2 million, an increase of $5.6 million, or 41.2%, from $13.6 million for the three months ended December 31, 2003. Cost of revenues for the three months ended December 31, 2004 increased to 72.2% of revenues compared to 69.7% of revenues for the three

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months ended December 31, 2003. The increase in total cost of revenues was due to increased FDG sales volume. Cost of revenues increased as a percentage of revenues due to the decrease in average revenue per dose as well as the opening of additional pharmacies.

     MTI. Cost of sales were less than $0.1 million for the three months ended December 31, 2004 compared to none for the three months ended December 31, 2003.

     Molecular Imaging Products. Cost of revenues for the three months ended December 31, 2004 was $9.9 million, an increase of $4.9 million, or 98.0%, from $5.0 million for the three months ended December 31, 2003. Cost of revenues for the three months ended December 31, 2004 increased to 72.2% of revenues compared to 69.4% of revenues for the three months ended December 31, 2003. The increase in total cost of revenues was due to the acquisition of Concorde in June 2004 and the increase in sales of cyclotron options and spare parts. Cost of revenues increased as a percentage of revenues due to higher production costs on cyclotrons.

Corporate and Eliminations

     Corporate and Eliminations. Intercompany cost of revenues that were eliminated in consolidation for the three months ended December 31, 2004 were $22.0 million, a decrease of $8.3 million, or 27.4%, from $30.3 million for the three months ended December 31, 2003. Cost of revenues eliminated for the three months ended December 31, 2004 were 19.7% of revenues compared to 40.9% of revenues for three months ended December 31, 2003. The decrease in cost of revenue eliminations was primarily due to decreased direct sales of PET and PET/CT scanners by Service and Distribution, which were purchased from CPS, as well as reduced transfer pricing on detector materials sold to CPS in accordance with the Agency Agreement.

Selling, General and Administrative Expenses

     Selling, general and administrative expenses for the three months ended December 31, 2004 were $16.8 million, an increase of $1.6 million, or 10.5%, from $15.2 million for the three months ended December 31, 2003. Selling, general and administrative expenses for the three months ended December 31, 2004 were 15.1% of revenues compared to 20.5% of revenues for the three months ended December 31, 2003.

Clinical Scanner Business

     CPS. Selling, general and administrative expenses for the three months ended December 31, 2004 were $3.3 million, a decrease of $1.2 million, or 26.7%, from $4.5 million for the three months ended December 31, 2003. Selling, general and administrative expenses for the three months ended December 31, 2004 were 4.9% of revenues compared to 8.1% of revenues for the three months ended December 31, 2003. The decrease is due to reduced selling and marketing costs as Siemens has assumed most selling and marketing activities for CPS products in conjunction with the execution of the Agency Agreement.

     Detector Materials. Selling, general and administrative expenses for the three months ended December 31, 2004 were $0.9 million, an increase of $0.2 million, or 28.6%, from $0.7 million for the three months ended December 31, 2003. As a percentage of revenues, selling, general and administrative expenses were 11.7% and 5.8% for the three months ended December 31, 2004 and 2003, respectively. The increase is primarily attributable to increased administrative costs from the implementation of a new management information system during the second quarter of fiscal year 2004. The increase in selling, general and administrative expenses as a percentage of revenue is attributable to the significant decrease in revenues from the same period in fiscal year 2004.

     Service and Distribution. Selling, general and administrative expenses for the three months ended December 31, 2004 were $3.0 million, a decrease of $1.6 million, or 34.8%, from $4.6 million for the three months ended December 31, 2003. As a percentage of revenues, selling, general and administrative expenses were 17.4% and 33.1% for the three months ended December 31, 2004 and 2003, respectively. The decrease in total selling, general and administrative expense both in total and as a percentage of revenue is attributable to the decision to exit the scanner direct distribution business. The $2.0 million of underlying expenses for the sales and marketing services provided to Siemens as defined in the Agency Agreement are included in selling, general and administrative expenses, while the reimbursement from Siemens is reflected in revenues.

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Molecular Biomarker Technologies

     PETNET. Selling, general and administrative expenses for the three months ended December 31, 2004 were $5.5 million, an increase of $1.2 million, or 27.9%, from $4.3 million for the three months ended December 31, 2003. As a percentage of revenues, selling, general and administrative expenses for the three months ended December 31, 2004 were 20.7% compared to 22.1% for the three months ended December 31, 2003. The $1.2 million increase is attributable to increased personnel to provide marketing support for the expanding PETNET network. The decrease in expenses as a percentage of revenue is attributable to the sales growth exceeding the increase in spending.

     MTI. Selling, general and administrative expenses for the three months ended December 31, 2004 were $0.3 million, compared to none for the three months ended December 31, 2003. The increase is attributable to the addition of administrative personnel.

     Molecular Imaging Products. Selling, general and administrative expenses for the three months ended December 31, 2004 were $2.6 million, an increase of $1.1 million, or 73.3%, from $1.5 million for the three months ended December 31, 2003. As a percentage of revenues, selling, general and administrative expenses for the three months ended December 31, 2004 were 19.0% compared to 20.8% for the three months ended December 31, 2003. The increase in amount is primarily attributable to the acquisition of the business and assets of Concorde in June 2004 and the acquisition of ImTek in November 2004.

Corporate and Eliminations

     Corporate and Eliminations. Selling, general and administrative expenses for the three months ended December 31, 2004 were $1.2 million, an increase of $1.6 million from $(0.4) for the three months ended December 31, 2003. The increase is primarily attributable to increased corporate marketing costs that are not allocated to the reporting segments.

Research and Development Expenses

     Research and development expenses for the three months ended December 31, 2004 were $9.3 million, a decrease of $1.0 million, or 9.7%, from $10.3 million for the three months ended December 31, 2003. Research and development expenses for the three months ended December 31, 2004 were 8.3% of revenues compared to 13.9% for the three months ended December 31, 2003.

Clinical Scanner Business

     CPS. Research and development expenses for the three months ended December 31, 2004 were $5.8 million, a decrease of $0.9 million, or 13.4% from $6.7 million for the three months ended December 31, 2003. Research and development expenses for the three months ended December 31, 2004 were 8.7% of revenues compared to 12.1% for the three months ended December 31, 2003. CPS continued to invest in new scanner technology primarily devoted to PET/CT and LSO scanner developments. The decrease in the amount is attributable to the timing of underlying project expenses. The decrease in expenses as a percentage of revenue is attributable to the sales growth exceeding research and development spending.

     Detector Materials. Research and development expenses for the three months ended December 31, 2004 and 2003 were $0.2 million. Research and development expenses for the three months ended December 31, 2004 were 2.6% of revenues compared to 1.7% for the three months ended December 31, 2003. The increase as a percent of revenue is due to the decrease in revenues while research and development expenses remained constant.

     Service and Distribution. No research and development expense was incurred for the three months ended December 31, 2004 and 2003.

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Molecular Biomarker Technologies

     PETNET. Research and development expenses for the three months ended December 31, 2004 were $0.8 million, a decrease of $0.2 million, or 20.0%, from $1.0 million for the three months ended December 31, 2003. Research and development expenses for the three months ended December 31, 2004 were 3.0% of revenues compared to 5.1% for the three months ended December 31, 2003. The $0.2 million decrease is primarily due to the timing of project spending. The decrease in expenses as a percentage of revenue is also attributable to the sales growth exceeding spending.

     MTI. Research and development expenses for the three months ended December 31, 2004 were $1.0 million, an increase of $0.2 million, or 25.0%, from $0.8 million for the three months ended December 31, 2003. The increase is attributable to spending on new molecular probe technology and chemistry production equipment.

     Molecular Imaging Products. Research and development expenses for the three months ended December 31, 2004 were $1.6 million, a decrease of $0.1 million, or 5.9%, from $1.7 million for the three months ended December 31, 2003. Research and development expenses for the three months ended December 31, 2004 were 11.7% of revenues compared to 23.6% for the three months ended December 31, 2003. The decrease is primarily due to reduced spending on cyclotron related projects partially offset by increased spending on medical image analysis tools and increased research and development expenses due to the acquisition of Concorde in June 2004.

Corporate and Eliminations

     Corporate and Eliminations. Research and development expenses for the three months ended December 31, 2004 and 2003 were $(0.1) million.

Stock-based Compensation Expense

     Stock-based compensation expense for the three months ended December 31, 2004 was $1.5 million, a increase of $1.0 million, from $0.5 million for the three months ended December 31, 2003 Stock-based compensation expense for the three months ended December 31, 2004 was 1.3% of revenues compared to 0.7% for the three months ended December 31, 2003.

Clinical Scanner Business

     CPS. Stock-based compensation expense was $0.1 million for the three months ended December 31, 2004 and 2003. Stock-based compensation expense was 0.2% of revenues for the three months ended December 31, 2004 and 2003 and included charges for the vesting of options granted in 2002 with exercise prices below the fair market value of our stock. No similar grants were issued during the three months ended December 31, 2004 or 2003.

     Detector Materials. No stock-based compensation expense was incurred for the three months ended December 31, 2004 and 2003.

     Service and Distribution. Stock-based compensation expense decreased to $0 from $0.1 million for the three months ended December 31, 2003. Stock-based compensation expense was 0.7% of revenues for the three months ended December 31, 2003. Stock-based compensation expense in 2003 included charges for the vesting of options granted in 2002 with exercise prices below the fair market value of our stock. No similar grants were issued during the three months ended December 31, 2004 or 2003.

Molecular Biomarker Technologies

     PETNET. Stock-based compensation expense for the three months ended December 31, 2004 was $0.2 million, an increase of $0.1 million, or 100.0%, from $0.1 million for the three months ended December 31, 2003. Stock-based compensation expense for the three months ended December 31, 2004 was 0.7% of revenues compared to 0.5% for the three months ended December 31, 2003. The increase is attributable to a restricted share grant during the second quarter of fiscal year 2004.

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     MTI. Stock-based compensation expense for the three months ended December 31, 2004 was $0.3 million, compared to none for the three months ended December 31, 2003. The increase is attributable to issuances of deferred stock units during the second half of fiscal year 2004 to members of MTI’s board of directors, for which the related market value of the deferred stock units is being amortized over the vesting period.

     Molecular Imaging Products. No stock-based compensation expense was incurred for the three months ended December 31, 2004 and 2003.

Corporate and Eliminations

     Corporate and Eliminations. Stock-based compensation expense for the three months ended December 31, 2004 was $0.9 million, an increase of $0.7 million, from $0.2 million for the three months ended December 31, 2003. The increase is attributable to current year issuances of restricted stock shares to a senior executive and deferred stock units to members of the Company’s board of directors, for which the market values are being amortized over the vesting periods. In addition, the vesting schedule on certain options previously issued to a senior executive were accelerated, resulting in a remeasurement of the stock options’ fair value. Stock-based compensation was increased to reflect the increase in the stock options’ fair values and the accelerated vesting schedules.

Income (Loss) from Operations

     Income from operations for the three months ended December 31, 2004 was $14.2 million, an increase of $9.8 million, from $4.4 million for the three months ended December 31, 2003. Income from operations for the three months ended December 31, 2004 was 12.7% of revenues compared to 5.9% for the three months ended December 31, 2003.

Clinical Scanner Business

     CPS. Income from operations for the three months ended December 31, 2004 was $13.9 million, an increase of $7.6 million, from $6.3 million for the three months ended December 31, 2003. Income from operations for the three months ended December 31, 2004 was 20.7% of revenues compared to 11.3% for the three months ended December 31, 2003. This increase in operating profits is primarily due to increased revenues and resulting gross profits and decreased operating expenses.

     Detector Materials. Income from operations for the three months ended December 31, 2004 was $2.8 million, a decrease of $3.9 million, or 58.2%, from $6.7 million for the three months ended December 31, 2003. Income from operations for the three months ended December 31, 2004 was 36.4% of revenues compared to 55.8% for the three months ended December 31, 2003. The decrease resulted primarily from the reduction of the LSO transfer prices to CPS in accordance with the Agency Agreement, the sale of higher cost inventories purchased as a result of an arbitration order issued during fiscal year 2004, and increase selling, general and administrative expenses.

     Service and Distribution. The operating loss for the three months ended December 31, 2004 was $0.7, a decrease of $3.2 million, or 82.1% from the loss of $3.9 million for the three months ended December 31, 2003. Loss from operations for the three months ended December 31, 2004 was 4.0% of revenues compared to 28.0% for the three months ended December 31, 2003. The decrease in the loss was primarily attributable to the reimbursement of sales and marketing expenses for services provided to Siemens in accordance with the Agency Agreement.

Molecular Biomarker Technologies

     PETNET. Income from operations for the three months ended December 31, 2004 was $0.9 million, an increase of $0.4 million, or 80.0%, from $0.5 million for the three months ended December 31, 2003. Income from operations for the three months ended December 31, 2004 was 3.4% of revenues compared to 2.6% for the three months ended December 31, 2003. The increase is primarily attributable to the growth in revenues and margin exceeding operating expense growth.

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     MTI. Loss from operations for the three months ended December 31, 2004 was $1.4 million, an increase of $0.6 million, or 75.0%, from the loss of $0.8 million for the three months ended December 31, 2003. The increase is primarily attributable to increased research and development spending and the addition of administrative personnel.

     Molecular Imaging Products. The operating loss for the three months ended December 31, 2004 was $0.4 million a decrease of $0.6 million, or 60.0%, from the loss of $1.0 million for the three months ended December 31, 2003. Loss from operations for the three months ended December 31, 2004 was 2.9% of revenues compared to 13.8% for the three months ended December 31, 2003. The decrease in the loss from operations is primarily attributable to the increased third party cyclotron sales and the resulting increase in margin.

Corporate and Eliminations

     Corporate and Eliminations. Loss from operations for the three months ended December 31, 2004 was $0.9 million, a decrease of $2.5 million, or 73.5% from the loss from operations of $3.4 million for the three months ended December 31, 2003. The majority of this decrease represents the net change in the consolidation entry to eliminate the intercompany gross margin on detector material inventory held by CPS and PET scanner inventory held by Service and Distribution at each period end. As intercompany sales of scanners have decreased the related margin elimination has also decreased.

Interest Expense, Net

     Interest expense for the three months ended December 31, 2004 was $0.2 million, a decrease of $0.3 million, from $0.5 million for the three months ended December 31, 2003. The decrease in interest expense resulted from reduced letter of credit charges and lower capital lease and debt balances.

Other Income

     Other income for the three months ended December 31, 2004, decreased to $0 from $0.6 million for the three months ended December 31, 2003. The decrease is primarily attributable to decreased gains on foreign currency transactions.

Provision for Income Taxes

     The income tax provision for the three months ended December 31, 2004 was $5.3 million, an increase of $3.6 million, from $1.7 million for the three months ended December 31, 2003. The effective tax rate for the three months ended December 31, 2004 was 37.7%. The effective tax rate for the three months ended December 31, 2003 was 37.6%.

Minority Interests

     The minority interest expense for the three months ended December 31, 2004 was $4.7 million, an increase of $2.6 million from $2.1 million for the three months ended December 31, 2003. Minority interest expense primarily consists of Siemens’ 49.9% share of the net income of CPS.

Liquidity and Capital Resources

     Our principal liquidity requirements are to meet the working capital and capital expenditure needs of our expanding business. These needs have increased in order to support the growth in our business. For example, from September 30, 2004 to December 31, 2004, our total accounts receivable increased from $100.2 million to $119.9 million, offset by a decrease in inventory from $92.2 million to $85.3 million. The decrease in inventory is primarily due to a reduction in scanner inventory due to our decision to exit the direct distribution business, while the increase in accounts receivable is primarily attributable to the increasing amount of sales to Siemens and a brief delay in the timing of payments from Siemens. The brief delay was corrected during January 2005. A greater majority of our scanners are

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now sold through distributors with payment terms that are faster than the terms for our direct distribution sales to end customers. Our property and equipment (net) increased from $133.1 million to $137.2 million during this same period. Property and equipment increased due to the continued expansion of our radiopharmacy network and development of our South Korean operation.

     On September 30, 2002 we entered into an amended and restated credit agreement with a syndicate of banks agented by SunTrust Bank. The credit agreement makes available to us up to $125 million in revolving loans, with a $10 million sub-limit for letters of credit. Of this total, CPS is allowed to borrow up to $55.0 million to finance its operations. Total availability under the credit agreement may be limited from time to time based on the value of certain of our assets and by our earnings before interest, taxes, depreciation, amortization, and minority interest (referred to as EBITDAM). Our subsidiaries guarantee all obligations under the credit agreement, except that the guarantee of CPS is limited to $55 million and does not include any advances under the credit agreement that are loaned (on an intercompany basis) to our PETNET subsidiary. Our obligations and the obligations of our subsidiary guarantors under the credit agreement are secured by a lien on substantially all of our assets (including the capital stock or other forms of ownership interests we hold in our subsidiaries) and the assets of our subsidiary guarantors, except that the lien securing the guarantee obligations of CPS is principally limited to the accounts receivable and inventory of CPS. As of December 31, 2004 no balance was outstanding under the credit agreement, and after deducting $6.6 million in outstanding letters of credit, $118.4 million was available to the Company.

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

     CTI guarantees lease obligations for radiopharmacy facilities and equipment on behalf of unconsolidated investees in the maximum aggregate amount of $0.2 million at December 31, 2004. 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 were obligations 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 (or approximately $7.1 million at December 31, 2004). 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 $0.3 million for this guarantee to reflect the estimated fair value of the Company’s obligation in accordance with FIN 45.

     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% of the principal balance of the first $25 million in leases, and 5% thereafter, on all leases DLL executed on the Company’s behalf. At December 31, 2004, the Company had recorded a reserve of $0.3 million 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.

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     We anticipate that our current cash and cash equivalents balances and our expected operating cash flow, together with borrowings under our credit facility, will be sufficient to meet our future operating expenses, capital expenditures and debt service obligations through the expected date of the CPS put/call. Our decision to exit the direct distribution of scanners in conjunction with executing the Agency Agreement with Siemens should also improve cash flow as we will be able to reduce consolidated scanner inventory levels and receivables from third party customers. We may from time to time evaluate the benefits of raising additional debt or equity capital although there can be no guarantee that such debt or equity will be available at terms we believe are favorable.

Off-Balance Sheet Arrangements

     Other than as described above, we have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Cash Flows

Three months ended December 31, 2004 compared to three months ended December 31, 2003

     Net cash used in operating activities was $4.3 million for the three months ended December 31, 2004 and net cash provided by operating activities was $5.7 million for the three months ended December 31, 2003. The decrease in net cash from operating activities was primarily due to increasing accounts receivable balances from Siemens offset by efforts to reduce inventory on hand and improved operating results.

     Net cash used in investing activities during the three months ended December 31, 2004 and 2003 was $11.4 million and $5.4 million, respectively and consisted primarily of capital expenditures to expand our radiopharmacy network. Cash used during the three months ended December 31, 2004 also included $3.4 million net cash paid for the acquisition of ImTek.

     Net cash provided by financing activities during the three months ended December 31, 2004 was $3.0 million compared to net cash used of $5.6 million during the three months ended December 31, 2003. For the three months ending December 31, 2004 financing activities primarily related to changes in our cash management clearing account due to payments to vendors for material needed to support our fourth quarter sales.

Critical Accounting Policies

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

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

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Revenue Recognition

     We record revenue in accordance with the guidance of the SEC’s Staff Accounting Bulletin (SAB) No. 104 (SAB 104), which supersedes SAB 101 in order to encompass EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21). Our revenue is derived from sales of scanners, calibration sources, spare parts, detector materials, cyclotrons, radiopharmaceuticals, medical image analysis applications, sales and marketing services, and the provision of services on equipment sold, including site planning and installation, preventive maintenance and repair, training, technical support and assistance with licensing. 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. Revenues derived from the sale of scanners, cyclotrons, calibration sources, spare parts, medical image analysis applications and detector materials are recognized upon either shipment or arrival at destination depending on shipment terms. We account for sales of scanning equipment and related installation and associated training services as multiple-element arrangements. We recognize 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. We determine the value of the equipment and installation and training services based on sales of the equipment both with and without installation and training. We also recognize as revenue reimbursements for certain sales and marketing services as such services are provided to Siemens and as the Company is the primary obligor for the expenses incurred in providing these services.

     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 and SAB 104, and recognize revenue for equipment upon delivery and for installation and other services as performed. EITF 00-21 was effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003.

     Revenues derived from distribution of radiopharmaceuticals are recognized upon delivery of the product. Equipment maintenance service contracts are typically more than one year 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.

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

     Revenues derived from our software license sales are recognized in accordance with Statement of Position (SOP) No. 97-2, “Software Revenue Recognition,” and SOP 98-9, “Modifications of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions.” For software license sales for which any services rendered are not considered essential to the functionality of the software, we recognize revenue upon delivery of the software, provided (1) there is evidence of an arrangement, (2) collection of our fee is considered probable and (3) the fee is fixed and determinable. If professional services are considered essential to the functionality of the software, we will record revenue for the license and professional services over the implementation period using the percentage of completion method, measured by the percentage of labor hours incurred to date to estimated total labor hours for each contract.

     Revenue recognition depends on the timing of shipment and service performance and can be subject to customer readiness and acceptance. If services and shipments are not performed as scheduled, our reported revenues may differ materially from expectations.

Valuation of Goodwill

     On October 1, 2001, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets (SFAS 142) which required us to perform an initial impairment review of our goodwill at that date and also requires us to perform impairment reviews thereafter, at least once annually. We conduct our impairment test at the end of each fiscal year based on judgments regarding ongoing profitability and cash flow of

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the underlying assets. Changes in strategy or market conditions could significantly impact these judgments and require adjustments to recorded asset balances. For example, if we had reason to believe that our recorded goodwill had become impaired due to decreases in the fair market value of the underlying business, we would have to take a charge to income for that portion of goodwill that we believe is impaired. The annual impairment test was conducted and it did not result in any impairment charges.

Accounting for Investees

     We periodically enter into arrangements in which we hold a majority of the equity ownership. In some instances, we also have influence over a majority of the board of directors or managers. We determine accounting for these investments in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46(R), Consolidation of Variable Interest Entities (FIN 46(R)), SFAS No. 94, Consolidation of All Majority-Owned Subsidiaries (SFAS 94), and Accounting Principles Board (APB) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB 18) and, where appropriate, evaluate our and the minority shareholders’ participating rights in accordance with EITF Issue 96-16, Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights (EITF 96-16) to determine whether consolidation or equity method accounting is appropriate in each case.

     We evaluated FIN 46(R) effects on our investments during the second quarter of fiscal year 2004. In conjunction with this evaluation, we identified one of our investments as a variable interest entity as defined by FIN 46(R). However, the evaluation of FIN 46(R) did not have a significant impact on our consolidated financial statements since the Company is also identified as the primary beneficiary of the variable interest entity and therefore is not required to make changes to the entities included in the consolidated financial statements for this reporting period. As required by FIN 46(R), we will continue to monitor our investments in both consolidated and unconsolidated entities for events that may occur which would require the Company to reevaluate whether any of these investments qualifies as a variable interest entity. The evaluation of FIN 46(R) did not result in changes in the application of previously issued generally accepted accounting principles, SFAS 94 and APB 18, to our investments.

     We own a majority interest in CPS. Under the terms of the CPS operating agreement, we have 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 us, two directors selected by Siemens, and a fifth director selected by Siemens from a list of persons selected by us. 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 our financial statements.

     Where appropriate, we evaluate our and the minority interest shareholders’ participating rights in accordance with EITF 96-16 to determine whether consolidation or equity method accounting is appropriate in each case. In cases where the minority shareholder is deemed to have “veto rights” or has equal representation on the board of directors, we account for these investments using the equity method as we do not have control over significant operating decisions. We have invested in three radiopharmacies that are accounted for under the equity method. For the entities not previously included in the consolidated financial statements, the evaluation of FIN 46(R) resulted in us continuing to apply previously issued generally accepted accounting principles to the respective investments and continuing to account for these entities under the equity method.

Recent Accounting Pronouncements

Share-Based Payment

     In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R eliminates the ability to account for share-based compensation transactions using the intrinsic value method under APB 25, and generally would require instead that such transactions be accounted for using a fair-value-based method. The Company is currently evaluating SFAS 123R to determine which fair-value-based model and

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transitional provision it will follow upon adoption. The options for transition methods as prescribed in SFAS 123R include either the modified prospective or the modified retrospective methods. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock as the requisite service is rendered beginning with the first quarter of adoption, while the modified retrospective method would record compensation expense for stock options and restricted stock beginning with the first period restated. Under the modified retrospective method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. SFAS 123R will be effective for the Company beginning in its fourth quarter of fiscal 2005. Although the Company will continue to evaluate the application of SFAS 123R, management expects adoption of this standard to have a material impact on its results of operations.

Inventory Costs

     On November 24, 2004, the FASB issued SFAS No. 151, Inventory Costs- an amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 amends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter 4, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that these costs be recognized as current period charges regardless of whether they are abnormal. In addition, SFAS 151 requires that allocation of fixed production overheads to the costs of manufacturing be based on the normal capacity of the production facilities. SFAS 151 shall be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not expect SFAS 151 to have a material effect on its financial statements.

Exchange of Nonmonetary Assets

     In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No. 29 (SFAS 153). SFAS 153 addresses the remeasurement of exchanges of nonmonetary assets. This statement eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets within APB Opinion No. 29, and replaces it with an exception for exchanges that do not have commercial substance. The provisions of SFAS 153 shall be effective for nonmonetary transactions occurring in fiscal periods beginning after June 15, 2005. The Company will apply the provisions of SFAS 153 if we exchange nonmonetary assets.

Factors Affecting Operations and Future Results

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

     The market for molecular imaging equipment and related products and services is intensely competitive and is affected significantly by new product introductions, aggressive pricing strategies of competitors and other marketing activities of industry participants. We compete directly with a number of other companies in the molecular imaging equipment market including GE Healthcare (formerly known as GE Medical Systems) and Philips Medical Systems. We also compete with Siemens for renewals of service contracts on the installed base of CPS scanner customers shipped prior to the Agency Agreement. The intense and increasing competition in the molecular imaging equipment market has caused and may continue to cause downward pressure on the pricing of our molecular imaging equipment and/or service contracts. In our radiopharmaceutical business, we compete with for-profit corporations, such as Cardinal Health, Inc. and ION Beam Applications s.a. (and its subsidiary, Eastern Isotopes), as well as regional pharmacies and universities. The intense and increasing level of competition in the market for radiopharmaceuticals and the generic nature of the radiopharmaceuticals currently in production have caused and may continue to cause downward pressure on pricing. Many of our competitors are significantly larger than us and enjoy competitive advantages over us, including:

	•	Significantly greater name recognition;
	•	Better established distribution networks and relationships with health care providers, group purchasing entities and third-party payors;

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	•	Additional lines of products and the ability to offer rebates, provide upgrades to previously installed machines or bundle products in order to offer discounts or incentives;
	•	Greater ability to finance capital equipment sales for their customers; and
	•	Greater resources for product development, sales and marketing and patent prosecution and litigation.

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

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

     Our ability to reach our overall sales goals for scanners is dependent upon the sales and marketing efforts of our existing and future third-party distributors, including Siemens, Hitachi Medical Systems America and Toshiba Medical Systems Corporation. For example, for the three month periods ended December 31, 2004 and 2003 sales to Siemens constituted 58.7% and 45.2%, respectively, of our consolidated revenues. If we fail to sell a large volume of our scanners through our distributors, we could experience a decline in overall sales. None of our current scanner distributors is obligated to continue selling, or to commit the necessary resources to effectively market and sell, our scanner products.

     Effective May 1, 2004, CTI, CPS, and Siemens executed an agreement appointing CTI as Siemens’ non-exclusive sales representative to solicit purchases of Siemens-branded PET and PET/CT scanners manufactured by CPS in the United States. This agreement provides for us to cease our direct distribution of PET and PET/CT scanners, with the exception of certain rights retained in South Korea and Japan. In compliance with this agreement, we have ceased direct distribution of CPS’ scanner products and terminated our sub-distribution agreements outside of the U.S. as required, yet retained those agreements as permitted in South Korea and Japan. Following this change, our dependence on our third-party distributors, especially Siemens, has increased for sales growth and market information used to develop future guidance.

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

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

     Medicare reimbursement rates are established by the U.S. Department for Health and Human Services’ Centers for Medicare and Medicaid Services (CMS), the government agency that administers Medicare and Medicaid. From time to time, CMS adjusts the reimbursement rates for medical procedures to reflect the costs incurred by health care providers to perform the procedures. Medicare reimbursement rates for PET applications have recently declined and are subject to periodic reevaluation by CMS which could cause further downward adjustments in the future.

     Today there is no standard reimbursement rate for PET procedures among private third-party payors such as indemnity insurers, health maintenance organizations and preferred provider organizations. In our experience, private payors typically reimburse health care providers for PET procedures at approximately the same rate as Medicare. However, the reimbursement rates offered by private payors are market-driven and are therefore subject

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to market conditions. For example, in markets with significant competition among health care providers, the reimbursement rates can be driven downward due to competitive contracting between third-party payors and health care providers. The reimbursement rates offered by private payors for procedures conducted with our products could be negatively impacted by market conditions or by a decrease in Medicare reimbursement rates.

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

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

     For the three month periods ended December 31, 2004, and 2003, approximately 55.3% and 50.6%, respectively, of our consolidated revenues were derived from the sale of PET equipment manufactured by our 50.1% owned subsidiary, CPS. Siemens owns the remaining 49.9% of CPS pursuant to a joint venture agreement that we entered into with Siemens in 1987. According to this joint venture agreement, Siemens has an option to acquire from us for cash up to an 80% interest in CPS, if and when CPS achieves specified unit sales volumes. Siemens’ right to exercise this option is contingent upon CPS selling, during the year preceding exercise, in excess of the cumulative total number of units specified in the “Siemens minima plus 20% plan” attached to the joint venture agreement. The “Siemens minima plus 20% plan” provides for annual increases in the cumulative total number of units sold by CPS beginning on December 9, 1987. As of December 31, 2004, the cumulative total number of units sold by CPS under this agreement was 889, and at such date, CPS would need to have sold a cumulative total of 1,129 units to achieve the required cumulative sales level for the option to be exercisable. After 2004, the cumulative unit sales requirement will continue to increase by 74 units each year. It is impossible to state definitively when the option will become exercisable; however, we currently believe that the specified sales volumes are not likely to be met before the second half of fiscal year 2006. Siemens cannot exercise its option until the end of the fiscal year in which this target level is reached. Once these sales volumes are achieved and the call right is exercised, we have the right to defer the exercise of the option for one year. If Siemens exercises its option and increases its ownership interest in CPS to 80%, Siemens could use that controlling ownership interest to cause CPS to engage in a transaction the effect of which would be a purchase by Siemens of our remaining 20% ownership interest in CPS. Accordingly, the Siemens option effectively gives Siemens the ability to acquire 100% of CPS.

     Under the terms of our new Agency Agreement with Siemens, in the event the Agency Agreement is terminated or not renewed by Siemens for any reason, we would continue to have the right to distribute PET and PET/CT products manufactured by CPS until at least 2010 on substantially the same terms as existed under the distribution agreement between CTI and CPS. The Agency Agreement also provides that CTI can terminate this agreement under certain specified circumstances, including the event that certain total unit sales thresholds for PET and PET/CT scanners are not met for a period of two consecutive fiscal quarters. The joint venture agreement also contains cross-covenants not to compete, which prohibit the parties to the joint venture agreement from participating in or owning an interest in any business engaged in the manufacture, development, or sale of products that compete with the products offered by CPS currently, and for a period of three years following the closing of the exercise of the Siemens’ option.

     The exercise of the Siemens option would eliminate a large portion of our revenues, operations and assets, including some valuable employees and intellectual property assets relating to the manufacture and development of PET scanners. As of December 31, 2004, approximately 37.3% of our total assets was attributable to CPS. Accordingly, if we fail to further diversify our business beyond that which is conducted by CPS, or if we fail to deploy effectively the option exercise proceeds received from Siemens, the exercise of the Siemens option could have a material adverse effect on our business. In addition, the existence of the Siemens option, even if not exercised, could negatively impact the market price of our common stock and limit our ability to enter into transactions or business relationships with companies that have competitive PET products. Further, we cannot assure you that the proceeds received upon exercise of the option will adequately compensate us for the loss of control of CPS.

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

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

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

	§	Properly identify customer needs;
	§	Prove feasibility of new products;
	§	Limit the time required from proof of feasibility to routine products;
	§	Limit the timing and cost of regulatory approvals;
	§	Price our products competitively;
	§	Manufacture and deliver our products in sufficient volumes on time, and accurately predict and control costs associated with manufacturing, installation, warranty and maintenance of the products;
	§	Manage customer acceptance and payment for products;
	§	Limit customer demands for retrofits of both new and old products; and
	§	Anticipate and compete successfully with competitors’ efforts.