United States
Securities and Exchange Commission

Form 10-Q

     (Mark One)

Commission File Number:                     000-49867

CTI MOLECULAR IMAGING, INC.

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

As of May 3, 2004, the registrant had outstanding 45,543,843 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 March 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 consolidated financial statements.

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CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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

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CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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

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CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

1. Organization and Presentation

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

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

2. Summary of Significant Accounting Policies

     Interim Financial Statements — The unaudited 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 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 latest Annual Report on Form 10-K filed with the SEC on December 23, 2003. Information in the accompanying consolidated financial statements and notes to the financial statements for the three month and six month periods ended March 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 and six month periods ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending September 30, 2004 or any future period.

     Principles of Consolidation — All significant intercompany balances and transactions have been eliminated. The Company periodically enters into arrangements in which it holds a majority of the equity ownership. In some instances, the Company also has influence over a majority of the board of directors or managers. The Company determines accounting for these investments under Financial Accounting Standards Board (FASB) Interpretation No. 46(R) (FIN 46(R)), Statement of Financial Accounting Standard (SFAS) No. 94 and Accounting Principles Board (APB) Opinion No. 18 and, where appropriate, evaluates its and the minority shareholders’ participating rights in accordance with Emerging Issues Task Force (EITF) Issue 96-16 to determine whether consolidation or equity method accounting is appropriate in each case.

     The Company adopted FIN 46(R) during the second quarter of fiscal year 2004. In conjunction with this adoption, the Company identified one of its investments as a variable interest entity as defined by FIN 46(R). However, the adoption of FIN 46(R) did not have a significant impact on the Company’s 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), the Company will continue 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.

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     For the entities previously included in the consolidated financial statements, the application of FIN 46(R) resulted in the Company continuing to apply previously issued generally accepted accounting principles to the respective investments. Accordingly, for these investments the Company applies SFAS No. 94 and APB Opinion No. 18 to determine whether consolidation or equity method is appropriate in each case.

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

     CTI Solutions through our subsidiary, PETNET Pharmaceuticals, Inc. (PETNET), owns 90.0% and 51.0% interests in radiopharmacies in Denver and Houston, respectively. Under the terms of the Denver and Houston radiopharmacy operating agreements, CTI Solutions has control over all significant operating decisions and these radiopharmacies are consolidated in our financial statements. CTI Solutions accounted for the Houston joint venture under the equity method in the financial statements prior to March 2003 in accordance with EITF 96-16. In March 2003, an amendment to the joint venture agreement was adopted that removed the participating rights of the minority partner. Accordingly, CTI Solutions is now deemed to have control over the significant operating decisions of the joint venture and the entity was consolidated in the Company’s financial statements effective March 1, 2003.

     Where appropriate, the Company evaluates its and the minority interest shareholders’ participating rights in accordance with EITF Issue 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 four radiopharmacies that are accounted for under the equity method. For the entities not previously included in the consolidated financial statements, the application 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 records revenues in accordance with the guidance of the SEC’s Staff Accounting Bulletin No. 104 (SAB 104), which supersedes SAB 101 in order to encompass EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21). Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the contract price is fixed or determinable, and collectibility is reasonably assured. No right of return privileges are granted to customers after shipment.

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

     For arrangements with multiple deliverables, such as scanner and cyclotron sales, we recognize product revenue by allocating the revenue to each deliverable based on the fair value of each deliverable in accordance with EITF 00-21 and SAB 104. EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after

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June 15, 2003. Due to our adoption of the provisions of EITF 00-21 the Company can now, for cyclotron arrangements entered into after July 1, 2003, separate cyclotron equipment from cyclotron installation services and recognize revenue for cyclotron equipment upon shipment and for cyclotron installation as services are performed. Prior to the implementation of EITF 00-21, the Company recognized revenue for all cyclotron sales in accordance with SAB 101 and did not recognize revenue for cyclotron system sales until installation was complete and customer acceptance was obtained, as functionality was deemed essential for cyclotrons. In accordance with transition provisions of EITF 00-21, revenue recognition for any cyclotron system sales, for which contracts were entered into prior to July 1, 2003 will continue to be accounted for under SAB 104 with revenue recognition deferred until installation is complete and customer acceptance is obtained.

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

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

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

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

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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 and six month periods ended March 31, 2004 and 2003 because including them would have had an antidilutive effect:

     Other Assets — Other assets include purchased technology arising from the Mirada Solutions Limited acquisition, long-term lease receivables, precious metals utilized in the production of detector materials, other long-term receivables and investments accounted for under the equity method. Purchased technology, patents, and trademarks are presented at cost, net of accumulated amortization. Intangible assets with finite lives are amortized over their estimated useful lives of 5 to 10 years using the straight-line method. Amortization expense for the three month and six month periods ending March 31, 2004 was $344 and $688, respectively, and has been recorded in cost of sales. There was no amortization expense during the three month and six month periods ending March 31, 2003.

Recent Accounting Pronouncements

     Consolidation of Variable Interest Entities - On January 17, 2003, the FASB issued FIN 46(R), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 Consolidated Financial Statements. FIN 46(R) expands upon and strengthens existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. A variable interest entity is any legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for th