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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Commission File Number: 000-49867

CTI Molecular Imaging, Inc.

(865) 218-2000

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

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

Common Stock, $0.01 par value

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

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

Table of Contents

CTI MOLECULAR IMAGING, INC.

TABLE OF CONTENTS

Table of Contents

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

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

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

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

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

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

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

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PART I

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

Item 1.     Business

Overview

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

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

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

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

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

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Industry Background

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

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

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

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

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

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

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

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

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

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

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

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

Business Strategy

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

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

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

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

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

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

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

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

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

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

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

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

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

Our Products and Services

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

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

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

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

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

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

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

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

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

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

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

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

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

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Research & Development

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

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

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

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

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Products Under Development

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

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

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

Our Relationship with Siemens

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Competition

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

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

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

Sales and Marketing

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

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

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

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

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

Customer Service and Support

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

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

      We believe customer service and support are an integral part of our competitive strategy. Service capability, availability and responsiveness play an important role in marketing and selling medical equipment and systems, pa