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

2

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.

3

CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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

4

CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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

5

CTI MOLECULAR IMAGING, INC. AND SUBSIDIARIES

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

6

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,

7

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.

8

     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:

9

     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-

10

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: